[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]



 
               INCREASING DISCLOSURE TO BENEFIT INVESTORS

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                    FINANCE AND HAZARDOUS MATERIALS

                                 of the

                         COMMITTEE ON COMMERCE
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             FIRST SESSION

                                   on

                         H.R. 887 and H.R. 1089

                               __________

                            OCTOBER 29, 1999

                               __________

                           Serial No. 106-70

                               __________

            Printed for the use of the Committee on Commerce



                      U.S. GOVERNMENT PRINTING OFFICE
61-039 CC                     WASHINGTON : 1999



                         COMMITTEE ON COMMERCE

                     TOM BLILEY, Virginia, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio               HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida           EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas                    RALPH M. HALL, Texas
FRED UPTON, Michigan                 RICK BOUCHER, Virginia
CLIFF STEARNS, Florida               EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio                FRANK PALLONE, Jr., New Jersey
  Vice Chairman                      SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania     BART GORDON, Tennessee
CHRISTOPHER COX, California          PETER DEUTSCH, Florida
NATHAN DEAL, Georgia                 BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma              ANNA G. ESHOO, California
RICHARD BURR, North Carolina         RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California         BART STUPAK, Michigan
ED WHITFIELD, Kentucky               ELIOT L. ENGEL, New York
GREG GANSKE, Iowa                    THOMAS C. SAWYER, Ohio
CHARLIE NORWOOD, Georgia             ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma              GENE GREEN, Texas
RICK LAZIO, New York                 KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming               TED STRICKLAND, Ohio
JAMES E. ROGAN, California           DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois               THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico           BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona             LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING, 
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland

                   James E. Derderian, Chief of Staff

                   James D. Barnette, General Counsel

      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

            Subcommittee on Finance and Hazardous Materials

                    MICHAEL G. OXLEY, Ohio, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     EDOLPHUS TOWNS, New York
  Vice Chairman                      PETER DEUTSCH, Florida
PAUL E. GILLMOR, Ohio                BART STUPAK, Michigan
JAMES C. GREENWOOD, Pennsylvania     ELIOT L. ENGEL, New York
CHRISTOPHER COX, California          DIANA DeGETTE, Colorado
STEVE LARGENT, Oklahoma              THOMAS M. BARRETT, Wisconsin
BRIAN P. BILBRAY, California         BILL LUTHER, Minnesota
GREG GANSKE, Iowa                    LOIS CAPPS, California
RICK LAZIO, New York                 EDWARD J. MARKEY, Massachusetts
JOHN SHIMKUS, Illinois               RALPH M. HALL, Texas
HEATHER WILSON, New Mexico           FRANK PALLONE, Jr., New Jersey
JOHN B. SHADEGG, Arizona             BOBBY L. RUSH, Illinois
VITO FOSSELLA, New York              JOHN D. DINGELL, Michigan,
ROY BLUNT, Missouri                    (Ex Officio)
ROBERT L. EHRLICH, Jr., Maryland
TOM BLILEY, Virginia,
  (Ex Officio)

                                  (ii)


                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Dickson, Joel M., Senior Investment Analyst, Vanguard Group..    17
    Fink, Matthew P., President, Investment Company Institute....    29
    Jones, David B., Vice President, FMR Co......................    22
    Mason, James L., Director of Public and Community Affairs, 
      Eaton Corporation..........................................     8
    Thompson, Robert B., George Alexander Madill Professor of 
      Law, Washington University.................................     4
Material submitted for the record by:
    American Society of Corporate Secretaries, letter dated 
      October 27, 1999, to Hon. Tom Bliley and Hon. Michael G. 
      Oxley......................................................    98
    Association of Publicly Traded Companies, letter dated 
      October 28, 1999, to Hon. Tom Bliley and Hon. Michael G. 
      Oxley......................................................    41
    Business Roundtable, The, letter dated July 23, 1999.........    42
    Dingell, Hon. John D., a Representative in Congress from the 
      State of Michigan, prepared statement with attachments.....    50
    OMB Watch, letter dated November 3, 1999, to Hon. Michael G. 
      Oxley......................................................    48
    Ridings, Dorothy S., President and CEO, Council on 
      Foundations, prepared statement of.........................    44
    Securities and Exchange Commission, prepared statement of....    46

                                 (iii)

  


               INCREASING DISCLOSURE TO BENEFIT INVESTORS

                              ----------                              


                        FRIDAY, OCTOBER 29, 1999

                  House of Representatives,
                             Committee on Commerce,
           Subcommittee on Finance and Hazardous Materials,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10 a.m., in 
room 2123, Rayburn House Office Building, Hon. Paul E. Gillmor 
presiding.
    Members present: Representatives Gillmor, Markey, and Cox.
    Staff present: Brent DelMonte, majority counsel; David 
Cavicke, majority counsel; Brian McCullough, majority 
professional staff; Robert Simison, legislative clerk; and 
Consuela Washington, minority counsel.
    Mr. Gillmor. The committee will come to order and we will 
proceed with the first bill. We have two bills up today and two 
panels, and we will do opening statements on the first bill, 
and then do the panel and then the same procedure on the second 
bill.
    I might tell those that are here that attendance is a 
little weak today because Congress is not in session. We were 
scheduled to be recessed, and when that happens, members leave 
town.
    I want to thank members on both panels for coming. I know 
that a number of you have come from some distance and we very 
much appreciate your lending us your time and your expertise.
    The first bill is H.R. 887, improved disclosure of 
charitable contributions by corporations, and I want to thank 
both Chairman Mike Oxley and ranking member Ed Towns who have 
cosponsored this legislation which I have introduced.
    Over 60 years ago, we determined as part of national policy 
that shareholders are entitled to receive relevant information 
from corporate management. Corporations give more than $8.5 
billion per year in charity, and there is no reason why 
shareholders should be denied knowledge of that information.
    Under current law if a corporation donates money to a 
charitable organization, the corporation is under no obligation 
to reveal anything about those gifts. Because those gifts are 
donated from shareholder earnings, a reasonable disclosure 
requirement is a matter of accountability. Now some 
corporations voluntarily disclose this type of information, 
including Eaton Corporation which is testifying today, and I 
want to commend those who voluntarily do disclose.
    This is not an issue about which groups receive charitable 
contributions from corporations, it is an issue of shareholder 
rights. Shareholders are the owners of a company's assets, and 
nothing in my legislation questions a company's commitment to 
social responsibility. Likewise, nothing in the legislation 
prohibits or restricts management's right to make donations or 
assess to whom or how much. I simply believe that shareholders 
have a right to review management's decisions and rationale.
    I have heard all of the arguments from companies and 
charities that feel threatened by this legislation. It is too 
costly, too burdensome. Shareholders are not interested. The 
amount of contributions is insignificant, given out to local 
companies, and more.
    Of the Fortune 100 companies which have provided SEC 
information about charitable giving, 53 percent of the number 
of cash contributions were $2,500 or less. A threshold of just 
$2,500 would require those companies to report less than half 
their contributions, and I would imagine that smaller companies 
would have to report less than that. Contributions of $2,500 or 
less, however, accounted for less than 4 percent of the total 
dollar amount. Less than 2 percent of the contributions exceed 
$100,000, but those contributions represent 46 percent of the 
total amount contributed.
    We are not talking about disclosing checks to the local 
boys' and girls' clubs, we are talking about significant 
contributions from shareholder earnings, and I have spent a lot 
of time working with both business and charity groups to find a 
workable disclosure requirement.
    The subcommittee did extend an invitation to the Business 
Roundtable to be with us today. I regret that they and a member 
company were not able to be here today, but we have met with 
them in the past and their views are certainly welcome at any 
time in the future as well.
    The fact is companies that do voluntarily disclose their 
giving haven't had those problems. Arguments raised from 
companies against the bill come mostly from managers who don't 
want to tell shareholders where they are giving the money away 
and use those arguments as excuses. If a CEO's spouse is the 
president of the Hula Hoop Foundation and the company gives 
$1,000 dollars to the Hula Hoop Foundation, and the company 
doesn't manufacture, sell, promote or have anything to do with 
Hula Hoops, then shareholders derive absolutely no benefit from 
those donations. Of course there is a natural self-interest in 
that case for the CEO to keep the donation out of the public 
eye. Transparency and integrity are the foundations upon which 
shareholders take a stake in our equity markets.
    Today over one-half of American families are invested in 
the stock market in one form or another. Millions of Americans 
are owners of our publicly held companies, and as more and more 
Americans take advantage of corporate ownership to secure their 
financial future, they assume a greater role in responsible and 
judicious charitable giving. Shareholders cannot participate in 
this great tradition unless they have access to this 
information.
    I requested that the SEC do a study on the feasibility of 
this bill, and the SEC did report back earlier this year and 
concluded, ``The corporate charitable disclosure requirements 
in H.R. 887 would be feasible in that companies are capable of 
tracking and disclosing this information to investors.''
    I would also like to note a small utterance by the SEC 
Chairman in a 1995 speech on disclosure. Chairman Levitt began 
by quoting Samuel Johnson saying, ``Where secrecy or mystery 
begins, vice or roguery is not far off.''
    I turn to the distinguished gentleman from Massachusetts, 
Mr. Markey.
    Mr. Markey. Thank you very much, Mr. Chairman. And I thank 
you very much for ensuring that we would have this very 
important hearing this morning which I hope can ultimately lead 
to legislative action.
    I am a cosponsor with you, Mr. Chairman, of H.R. 1089, The 
Mutual Fund Tax Awareness Act. This bill would direct the SEC 
to issue rules to ensure that mutual fund investors receive 
disclosure regarding the after-tax performance of their mutual 
funds. This type of information can be very useful to investors 
in combination with other types of disclosures required under 
existing rules in making an informed investment decision 
regarding the impact of capital gains on the overall 
performance of a mutual fund.
    While such disclosures, like all historical data regarding 
the past performances of a fund, does not have precise 
predictive value, it is nevertheless useful and important for 
investors to receive that type of information.
    The fact is because this industry is so competitive and 
because there are so many funds out there, factors such as fees 
and tax-adjusted performance can be a significant and material 
factor to an investor in choosing which fund to invest their 
money. The more information an investor has, the more likely 
they are going to make an informed decision. That is ultimately 
the only goal of this legislation. To put the information in 
the hands of the investor to as a result make them even more 
knowledgeable and then with the guarantee that nothing is 
guaranteed, they can make their investments in the mutual funds 
of their choice.
    So I hope, Mr. Chairman, that we can move forward on that 
legislation. I look forward to hearing from expert witnesses 
and I yield back the balance of my time.
    Mr. Gillmor. Thank you, Mr. Markey.
    [Additional statements submitted for the record follow:]
Prepared Statement of Hon. Michael G. Oxley, Chairman, Subcommittee on 
                    Finance and Hazardous Materials
    Today this Subcommittee will focus on two bills drafted by my 
colleague, Congressman Gillmor. Both of these bills, which I cosponsor, 
would provide investors with better investment information by mandating 
certain disclosures. Because educated investors make better decisions 
than those without reliable information, these bills will benefit 
investors in our country and throughout the world.
    The first bill we'll consider, H.R. 887, would require corporations 
to provide their shareholders with certain information about corporate 
giving. Responsible corporations play a major role in funding not-for-
profit organizations, and no one in the Congress wants to see 
corporations stop these beneficial activities. At the same time, 
corporations are under no obligation to disclose to their shareholders 
where shareholder money is being donated, even if the money is being 
funneled to a not-for-profit on which a director or a director's spouse 
serves, or to groups opposed by the majority of shareholders. While 
many corporations have taken it upon themselves to provide their 
shareholders with information about their charitable giving, most 
corporations still do not. Since corporate gifts are donated out of 
shareholder earnings, it is only reasonable to provide shareholders 
with information about where the money, which would otherwise be 
returned to them in the form of a dividend, is being spent.
    In our second panel we'll consider H.R. 1089, the Mutual Fund Tax 
Awareness Act, a bill which would provide mutual fund shareholders with 
better information about their funds' rates of return. According to 
Morningstar, 180 of the 756 all funds, or nearly one in four funds, 
which have been in existence for the past ten years have lost more than 
three percentage points per year on their claimed rates of return to 
taxes. The funds most likely to lose percentage points are those with 
high portfolio turnover, because if the fund manager is frequently 
turning over short-term gains in searching for better investments, the 
investors will have to pay taxes on this turnover on a yearly basis. 
Despite this fact, the overwhelming majority of funds still do not list 
performance figures on an adjusted, after-tax basis, even though they 
do list performance rates net of fees and expenses. This means that if 
an investor buys into a fund which claims a rate of return of 15%, but 
the investor isn't provided with information showing that the adjusted 
rate of return for the fund was only 10% after the investors paid their 
taxes, then that investor may have missed out on the opportunity of 
buying into a fund which better takes into account investor tax 
consequences when managing the fund.
    I want to commend Congressman Gillmor on his hard work in drafting 
these bills. They reflect a reasonable compromise between competing 
interests. I look forward to working with the members of this 
Subcommittee to ensure that investors are provided better information 
about their investments.
                                 ______
                                 
 Prepared Statement of Hon. Tom Bliley, Chairman, Committee on Commerce
    Mr. Chairman: It goes without saying that investors, and potential 
investors, benefit from reliable investment information. This 
investment information takes many forms. Today's hearing will focus on 
one form of this information: mandated corporate disclosure. 
Specifically, this hearing will consider two bills drafted by my 
colleague, Congressman Gillmor.
    The first bill upon which the Subcommittee will focus, H.R. 887, 
would amend the Securities and Exchange Act to require that 
corporations disclose certain information concerning their charitable 
giving. While there is no doubt that corporate giving is essential to 
the missions of many not-for-profits, at the same time it must be 
remembered that the money being given to these groups belongs to the 
shareholders, not the corporate board. It is important to give these 
shareholders more information about where their money is being spent, 
so we need to learn whether this bill would effectively accomplish that 
objective.
    The second bill, H.R. 1089, would require that the S.E.C. amend 
their regulations to require improved disclosure of mutual fund 
returns. It is a common industry practice to report mutual fund 
performance figures net of expenses and fees, but not net of taxes. 
Given that many non-index funds experience a high rate of turnover in 
their portfolios yearly, because investors must pay taxes on this 
turnover the actual rate of return investors enjoy frequently is less 
than what is reported by the funds. Providing investors, and potential 
investors, with information about the after-tax effects of portfolio 
turnover will better enable investors to properly choose the mutual 
fund which best suits their investment needs.
    Mr. Chairman, I commend Congressman Gillmor for his work on these 
bills, and you for scheduling this hearing. I look forward to hearing 
from our witnesses.

    Mr. Gillmor. We will proceed with Robert Thompson, who is 
from the University of Washington School of Law in St. Louis. 
Mr. Thompson.

   STATEMENTS OF ROBERT B. THOMPSON, GEORGE ALEXANDER MADILL 
 PROFESSOR OF LAW, WASHINGTON UNIVERSITY; AND JAMES L. MASON, 
  DIRECTOR OF PUBLIC AND COMMUNITY AFFAIRS, EATON CORPORATION

    Mr. Thompson. Thank you, Mr. Chairman. I am Robert Thompson 
of St. Louis, Missouri. I am a law faculty member at Washington 
University and Director of the Center for Interdisciplinary 
Studies at the Washington University School of Law. My 
statement is on behalf of myself and Professor Charles Elson 
who is a professor at Stetson University, a frequent writer 
about corporate governance and in fact a director to American 
corporations.
    I speak this morning about H.R. 887 which would require 
corporate disclosure of charitable contributions. We believe 
that would be a vital and welcome addition to a well-
functioning corporate system and could help ensure confidence 
and encourage participation in our Nation's capital markets.
    The corporate forum permits a specialization of function 
between managers and shareholders. It is one of the most 
distinctive parts of corporate law that separates and 
facilitates an efficient management structure and it permits 
the corporation to adapt to changed circumstances which is 
essential in our modern economy.
    At the same time, separation creates possible agency 
problems in that directors are given control over large pools 
of funds invested by the shareholders. Disclosure is the 
central mechanism used by Federal law to enable shareholders to 
effectively exercise their voting and other rights available to 
them under State corporate law. Disclosure of material 
charitable contributions, as would be required by H.R. 887, is 
consistent with the disclosure currently required under the 
Federal securities law. The more specific disclosure that would 
be required by this bill where there is a possibility of a 
conflict of interest as to the corporate insiders and the 
beneficiary of the corporate charitable contribution is 
consistent with the focus in Regulation S-K on disclosure 
relating to comment of interest generally.
    As with other expenditures of corporate money, shareholders 
desire that charitable contributions reflect a corporate 
purpose and do not simply become a gift of corporate assets to 
benefit the managers who direct the funds, but with no 
financial or emotional benefit to the shareholders themselves 
and to their collective enterprise.
    Today's corporate philanthropy sometimes functions to 
promote and aggrandize corporate managers with the benefit and 
the credit for the donations flowing to the individuals without 
any corresponding benefit to the entity and its owners.
    Consider the well-publicized case of Occidental Petroleum. 
When its long-time CEO, Armand Hammer, was unable to obtain 
satisfactory terms as to the donation of his art collection to 
the Los Angeles County Museum of Art, he turned to the company, 
Occidental, to build a museum to house the collection. The cost 
of the new building, the renovation of space for the museum's 
use in Occidental's headquarters next door, and property taxes 
and annuities to help fund the museum's initial operations 
approached $100 million. The company received some public 
recognition in the form of the right to name and use certain 
space in the building and certain sponsorship rights. Many 
believe the gift did little for the corporation's financial 
prospects or its shareholders but did a great deal for Mr. 
Hammer's standing in the art community.
    A challenge to this action under traditional State law 
corporate rules led to a settlement limiting the company's 
contributions. As required by appropriate corporate law 
procedures, the Delaware chancery court was asked to approve 
the settlement, but its language in doing so provides little 
reassurance as to the ability for the current legal structure 
to actively address the problem that you have mentioned this 
morning. The chancery said and I quote, ``If the court was a 
stockholder in Occidental it might vote for new directors. If 
it was on the board, it might vote for new management. And if 
it was a member of the special committee, it might vote against 
a museum property.'' But, the court continued, its options are 
limited in reviewing the proposed settlement and in fact the 
settlement was approved.
    This story is sadly not alone in our corporate landscape. 
Generally if a manager directs substantial contributions out of 
corporate funds to a charity with whom he or she is personally 
involved, there is the potential of a conflict of interest. If 
the charity has no relationship with the entity's business but 
provides the manager some form of personal benefit within the 
community, the possibility of self-dealing is real. Such a 
manager may not be the best steward of the shareholders's 
resources. Knowledge of those facts would clearly be material 
to shareholders in evaluating the performance of directors and 
directly relevant to their providing proxies to the election of 
directors. Current Federal regulation provides for direct 
conflict transactions, but does not provide for disclosure of 
charitable donations. Shareholders, therefore, cannot readily 
ascertain the existence of such a conflict. The House bill will 
provide the facts necessary for determining either the 
existence of such conflict or even the simple misapplication of 
shareholders' investment.
    While the benefit of such disclosure is substantial, the 
corresponding cost is not. Every public company that makes such 
charitable contributions annually collects information 
regarding those donations for reporting to the appropriate 
State and Federal taxation authorities. Requiring the 
disclosure of charitable contributions over a threshold amount 
will require no more than the repetition of information already 
collected and transmitted to government agencies. The 
disclosure contemplated by the proposed legislation greatly 
benefits the shareholding public at very little potential cost 
to the reporting companies. The proposed legislation is a 
focused and targeted effort that can be implemented consistent 
with existing Federal approach to securities disclosures. We 
urge you to make them part of our Federal securities laws.
    [The prepared statement of Robert B. Thompson follows:]
 Prepared Statement of Robert B. Thompson 1 and Charles M. 
                 Elson 2 regarding H.R. 887
---------------------------------------------------------------------------
    \1\ George Alexander Madill Professor of Law and Director, Center 
for Interdisciplinary Studies, Washington University School of Law, St. 
Louis, Missouri. Professor Thompson has taught corporations and 
securities law for more than 20 years. He is co-author of a 
corporations casebook widely used in American law schools and is a 
former chair of the Section of Business Associations of the Association 
of American Law Schools.
    \2\ Professor of Law, Stetson University School of Law, St. 
Petersburg, Florida. Professor Elson specializes in corporate 
governance research and is a director of two publicly held American 
companies. He is a member of the Advisory Council of the National 
Association of Corporate Directors; he organized a national working 
group of lawyers, investors, and law professors to discuss possible 
language and approach for this bill in 1998 and a seminar on corporate 
philantrophy in 1997.
---------------------------------------------------------------------------
    H.R. 887 requiring corporate disclosure of material charitable 
contributions is a vital and welcome part of a well-functioning 
corporate governance system that can insure investor confidence and 
encourages active participation in the national capital markets. It 
makes necessary changes that can be implemented at a minimal cost.
    The corporate form permits a specialization of function between 
directors and shareholders, for example, that facilitates an efficient 
management structure and permits the corporation to adapt to changed 
circumstances. At the same time, this separation creates possible 
agency problems in that directors are given control over large pools of 
funds invested by the shareholders. Disclosure is the central mechanism 
used by federal law to enable shareholders to effectively exercise 
their voting and other rights available to them under state corporate 
law.
    Disclosure of material charitable contributions as would be 
required by H.R. 887 is consistent with disclosure currently required 
under federal securities laws. The more specific disclosure that would 
be required when there is the possibility of a conflict of interest as 
to a corporate insider and the beneficiary of the corporate charitable 
contribution is consistent with the focus in Regulation S-K, for 
example, on disclosure relating to possible conflicts of interest.
    As with other expenditures of corporate money, the shareholders 
desire that charitable contributions reflect a corporate purpose and do 
not become simply a gift of corporate assets that benefits the manager 
who directs the corporate funds with no financial or emotional benefit 
to the shareholders themselves and their collective enterprise. Today's 
corporate philantrophy sometimes functions to promote and aggrandize 
corporate managers, with benefit and credit for the donations flowing 
to the individuals without any corresponding benefit to the entity and 
its owners. Consider the well-publicized case of Occidental Petroleum 
Corporation. 3 When its longtime CEO Armand Hammer was 
unable to obtain satisfactory terms as to the donation of his art 
collection to the Los Angeles County Museum of Art he turned to 
Occidental to build a museum to house his collection. The costs of the 
new building, renovation of space for the Museum's use in Occidental's 
headquarters next door, property taxes and an annuity to help fund the 
museum's initial operations exceeded $100 million. The company received 
some public recognition in the form of the right to name and use 
certain spaces and certain sponsorship rights. Many believe that the 
gift did little for the corporation's financial prospects or its 
shareholders but did a great deal for Mr. Hammer's standing in the art 
community.
---------------------------------------------------------------------------
    \3\ See Kahn v. Sullivan, 594 A.2d 48 (Del. 1991); see also Nell 
Minnow, What's Wrong with These Pictures? The Story of the Hammer 
Museum Litigation, in Law Stories 101 (Gary Bellow & Martha Minnow, 
Eds. 1996).
---------------------------------------------------------------------------
    A challenge to this action under traditional state law corporate 
rules led to a settlement limiting the company's contributions. As 
required by appropriate corporate law procedures, the Delaware Chancery 
Court approved the settlement but in language that provides little 
reassurance for the ability of the current legal structures to 
adequately address this problem: ``If the Court was a stockholder of 
Occidental, it might vote for new directors, if it was on the Board it 
might vote for new management and if it was a member of the Special 
Committee, it might vote against the Museum project. But its options 
are limited in reviewing a proposed settlement . . .'' 4 
This story is sadly not alone in our corporate landscape. 5
---------------------------------------------------------------------------
    \4\ Sullivan v. Hammer, No. 10823, 1990 Del. Ch. LEXIS 119, at *12 
(Del. Ch. Aug. 7, 1990) aff'd sub nom., Kahn v. Sullivan, 594 A.2d 48 
(Del. 1991).
    \5\ See also Jayne W. Barnard, Corporate Philanthropy, Executives' 
Pet Charities and the Agency Problem, 41 N.Y.L.S. L. Rev. 1147, 1160-64 
(1997) (examples of sizeable corporate contributions connected to CEO 
preferences).
---------------------------------------------------------------------------
    Generally, if a manager directs substantial contributions out of 
corporate funds to a charity with whom he or she is personally involved 
there is the potential of a conflict of interest. If the charity has no 
relationship with the entity's business, but provides the manager some 
form of personal benefit within the community, the possibility of self-
dealing is real. Such a manager may not be the best steward of the 
shareholders' resources. Knowledge of those facts would clearly be 
material to shareholders in evaluating the performance of directors, 
and directly relevant to their providing proxies for the election of 
directors. Current federal regulations provide disclosure for direct 
conflict transactions, but do not provide for disclosure of such 
charitable donations. 6 Shareholders therefore cannot 
readily ascertain the existence of such conduct, either malignant or 
benign. The House Bill will provide the facts necessary for determining 
either the existence of such conflicts of interest or even the simple 
misapplication of shareholders' investment. Information such as this is 
necessary to the shareholder's informed evaluation of company 
management which in turn is vital to a properly functioning capital 
market.
---------------------------------------------------------------------------
    \6\ See Faith Stevelman Kahn, Legislatures, Courts and the SEC: 
Reflections on Silence and Power in Corporate and Securities Law, 41 
N.Y.L.S. L. Rev. 1107 (1997).
---------------------------------------------------------------------------
    While the benefit of such disclosure is substantial, the 
corresponding cost is not. Every public company that makes such 
charitable contributions annually collects information regarding such 
donations for reporting to the appropriate state and federal taxation 
authorities. Requiring the disclosure of charitable contributions over 
a threshold amount will require no more than the repetition of 
information already collected and transmitted to governmental agencies. 
The disclosure contemplated by the proposed legislation greatly 
benefits the shareholding public at very little potential cost to the 
reporting companies.
    The proposed legislation is a focused and targeted effort that can 
be implemented consistent with the existing federal approach to 
securities disclosure. It applies only to reporting companies (and 
similar companies regulated under the Investment Company Act.) 
Subsection 1 requires disclosure of contributions to nonprofits when an 
issuer's director officer or control person (or a spouse of one of 
those) is a director or trustee of the nonprofit. It will require 
disclosure of contributions only above a threshold amount as designated 
by the Securities and Exchange Commission (``SEC''). Subsection 2 
requires additional disclosure of the total value of contributions made 
by a corporation and individual disclosure above a threshold that will 
be designated by the SEC. Unlike the disclosure in the previous 
section, this disclosure would appear not in the proxy report sent to 
all shareholders but in a filing as designated by the SEC. Because the 
reason for such disclosures differ from the reasons for conflict of 
interest disclosure, the nature of the disclosure may also differ. 
7
---------------------------------------------------------------------------
    \7\ See Melvin Aron Eisenberg, Corporate Conduct That Does Not 
Maximize Shareholder Gain: Legal Conduct, Ethical Conduct, The Penumbra 
Effect, Reciprocity, The Prisoner's Dilemma, Sheep's Clothing, Social 
Conduct and Disclosure, 28 Stetson L. Rev. 1, 25 (1998).
---------------------------------------------------------------------------
    These disclosures are consistent with, and considerably less 
complex than, existing disclosure as to conflict transactions as found, 
for example, in Item 404 of Regulation S-K. They reflect disclosure 
priorities found generally in Regulation S-K and other parts of the 
federal securities laws. We urge you to make them part of our federal 
securities law.

    Mr. Gillmor. Thank you very much, Mr. Thompson, and I want 
to announce that the record will remain open for others members 
to submit in writing their opening statements. James Mason from 
Eaton Corporation in Cleveland, Ohio.

                   STATEMENT OF JAMES L. MASON

    Mr. Mason. Good morning, Mr. Chairman. Thank you very much 
for the opportunity to appear this morning and talk a little 
bit about H.R. 887.
    I am Director of Public and Community affairs for Eaton 
Corporation, a global manufacturer headquartered in Cleveland, 
Ohio. It employs about 65,000 men and women worldwide at about 
215 manufacturing sites.
    Let me tell you about our overall contributions and 
community relations philosophy. As a global company, Eaton 
Corporation transcends national borders, crosses State lines 
and bridges cultural differences by providing jobs and economic 
stability. The company invests in itself and in the future with 
little fanfare. As background, we provided about $5 million 
last year to deserving nonprofit organizations and communities.
    Each year we look at the many causes called to our 
attention by our employees and apply our knowledge and skills 
to determine where we can provide the most benefit to those in 
need. Our first commitment is in those cities and towns and 
communities where our employees live and work. We support 
programs that aid education and strengthen the community as 
well as help those with limited opportunities and few 
resources.
    No less important than the dollars provided are the many 
hours that volunteers devote to making a difference in people's 
lives. This is part of the Eaton of which I am most proud. 
Across the company there are many unsung heroes who take the 
time to engage in these volunteer activities. Each year we 
honor those individuals with an award for community service 
named after one of our former chairmen, who like many in our 
company have had a tradition of volunteerism.
    It is clear as we approach the new millennium, 
technological advances have not provided the solutions to the 
human and social issues of our times. We have an opportunity 
and an obligation to strengthen the communities where we live 
and work and to help those less fortunate. To do less would be 
to deny that corporations have a mission beyond providing jobs 
and creating wealth. We believe otherwise, and we act on that 
belief.
    Our employees consistently give of their time, talent, and 
finances to support a variety of noteworthy programs and 
organizations. Grants are frequently awarded to organizations 
recommended by our employees who are involved in leadership 
roles and who are in a position to ensure the effective use of 
the company's investment.
    It has been our philosophy at Eaton to be open and candid 
in disclosing to whom our charitable contributions are made and 
the amount of our philanthropy. We do this in a volunteer 
manner and share this information with our board of directors, 
our employees and grant seekers. I have reports of our 
contributions, Mr. Chairman, with my testimony on our total 
philanthropy.
    In addition to our voluntary disclosure, we also meet with 
our board of directors on an annual basis, a committee of our 
board of public policy and social responsibility; it is a 
chance to view firsthand the projects and priorities that we 
are funding.
    But I am not sure, Mr. Chairman, that one size fits all. 
This works for a company such as Eaton. It has been in our 
history. We don't make that much in the way of corporate 
philanthropy that it is going to make a difference on the 
margin. We try to be supportive of the involvement of our 
people. That is where our money flows. I know that you have run 
some statistics as to whether this would have an impact on 
philanthropy. I am not sure, but I think anything that could 
have a possible chilling effect is something that we would not 
want to advocate.
    I know in talking to colleagues within the philanthropic 
community, Mr. Chairman, we have a very different opinion on 
this issue. Disclosure, as it indicates, I think is good for 
the process. I think mandating the types of elements may not 
be, and I would not advocate that.
    Thank you very much, Mr. Chairman.
    [The prepared statement of James L. Mason follows:]
  Prepared Statement of James L. Mason, Director, Public & Community 
                       Affairs, Eaton Corporation
                              introduction
    My name is Jim Mason and I am Director of Public & Community 
Affairs for Eaton Corporation. My company is a global manufacturer of 
highly engineered products that serve industrial, vehicle, 
construction, commercial, aerospace and semiconductor markets. 
Principal products include hydraulic products and fluid connectors, 
electrical power distribution and control equipment, truck drivetrain 
systems, ion implanters and a wide variety of controls. We are 
headquartered in Cleveland, Ohio--and employ 65,000 men and women at 
215 manufacturing sites in 25 countries around the world. Our 1999 
sales are expected to be nearly $9 billion.
                               background
    I am providing testimony in regards to H.R.887 regarding disclosure 
of corporate charitable contributions sponsored by Congressman Paul 
Gillmor. Let me begin by telling you about Eaton and its overall 
contributions and community relations' philosophy.
    As a global company, Eaton Corporation transcends national borders, 
crosses state lines and bridges cultural differences. By providing jobs 
and economic stability, the company invests in itself, in society and 
in the future. With little fanfare, Eaton provided nearly $5 million 
last year to deserving non-profit organizations and communities.
    Each year we look at the many causes called to our attention by our 
employees and apply our knowledge and skills to determine where we can 
provide the most benefit to those in need. Our first commitment is to 
the cities, towns, and villages where our employees live and work. We 
support programs that aid education and strengthen the community as 
well as help those with limited opportunities and few resources.
    Of no less importance than the dollars provided are the many hours 
that volunteers devote to making a difference in people's lives. This 
is the part of Eaton of which I am most proud. Across the company there 
are many unsung heroes who take the time to teach reading to the 
illiterate, coach little league softball, organize a school aid program 
or reach out in other ways to those in need. Each year we honor several 
of these volunteer leaders with the James R. Stover Awards for 
Community Service, named after one of our former chairmen, but there 
are many, many others who uphold this Eaton tradition of volunteerism.
    As we approach a new millennium, it is clear that technological 
advances have not provided solutions to the human and social issues 
that trouble our times. We have an opportunity and an obligation to 
strengthen the communities where we live and work and to help those 
less fortunate. To do less would be to deny that corporations have a 
mission beyond providing jobs and creating wealth. We believe otherwise 
and we act on that belief.
    Eaton employees consistently give of their time, talent and 
finances to support a variety of noteworthy programs and organizations. 
Grants are frequently awarded to organizations recommended by employees 
who are involved in leadership roles and who are in a position to 
ensure the effective use of the company's investment.
    It's been Eaton's philosophy to be open and candid in disclosing to 
whom our charitable contributions are made and the amount of our 
philanthropy--we do this voluntarily and share the information with our 
board of directors, employees and grant seekers. Enclosed with this 
commentary are reports of contributions that reflect our total 
philanthropy.
    What Congressman Gillmor is suggesting with H.R.887 is improved 
disclosure, openness and accountability--all very worthwhile goals. 
However, what is disturbing, in my opinion, is the provision that 
publicly held companies such as Eaton, would be required to list in our 
proxy statement, all contributions (amount to be determined by the SEC) 
to non-profit organizations that had a board member who is an executive 
of the corporation, or is an executive's spouse. Also, disclosure is 
required of the total amount of contributions in a year, along with the 
name of any non-profit receiving contributions exceeding a certain 
amount specified again by the SEC.
    I can understand that possibly these provisions were intended to 
prevent some individuals from becoming too directly involved on certain 
``pet projects'', but we want our executives and our associates 
actively involved with organizations and witnessing first-hand the 
delivery of services and providing oversight on governing boards. If 
the aforementioned provision is enacted, it is possible that a chilling 
affect will occur, not only would the non-profit experience some 
funding dilemmas, but active involvement would be lost as well.
    Although we choose to disclose our philanthropy voluntarily (not in 
a proxy statement), many other businesses for a variety of reasons 
choose not to disclose in the same manner as Eaton. It's been suggested 
that added cost would result from the proposed mandates, I am not 
certain as to the amount, but it would have an adverse impact on 
corporate philanthropy. And, that is what we don't need today--in the 
era of unprecedented economic growth, more corporate philanthropy by 
new small and medium sized businesses should be encouraged to do more 
for others in need in our society.

    Mr. Gillmor. Thank you very much, Mr. Mason.
    Let me ask both of you what would be, if any, the 
compelling public policy reason for shareholders not to know 
this information? Is there any?
    Mr. Thompson. Shareholders care about how the corporate 
money is spent, and there is a question of materiality in terms 
of at what level they would be concerned, but the bill seeks to 
address that by not requiring every disclosure but only that 
over a threshold. That is in response to the main argument, 
obviously.
    Mr. Mason. I think on that point, Mr. Chairman, our 
shareholders, at least through our board of directors, are 
fully informed and the report of contributions that we make 
available to the various public is open to shareholders. Do I 
send that to every shareholder of Eaton Corporation? I 
certainly do not. But it is available, Mr. Chairman, for them 
to review.
    Mr. Gillmor. One potential concern that you have raised is 
that it might have a chilling effect on contributions. Now 
there are other companies that publicly disclose, including 
some very big ones. Chevron is an example. But in your case, 
because you have been disclosing for years--and in fact I have 
seen your report, which is very good, and your disclosure goes 
far beyond anything that would be called for in this 
legislation--does the fact that Eaton discloses have a chilling 
effect on what you give?
    Mr. Mason. No, I don't think it has a chilling effect. I 
guess I am a little concerned that the implication drawn in the 
legislation of either the chairman or a member of the board or 
spouse would--that there would be something sinister, and maybe 
that is not the intended consequence.
    We do link a lot of our philanthropy, as you know, Mr. 
Chairman, with the involvement. We think that it is important 
that our people are not only giving of their own personal 
finances, but they are taking the time to have some oversight 
and governance on these organizations. I don't see anything 
wrong with that. I get concerned that if in the spirit of 
volunteerism we lose that pull by mandating certain types of 
openness beyond where we are open now.
    I think I would rather present this material in this 
fashion than include it in a proxy statement, for example, is 
what I am saying. I think for every example that Professor 
Thompson gave relative to the situation about Mr. Hammer, I 
don't think that we see that in corporate America. I can't 
speak to that end of it, certainly.
    Mr. Gillmor. Let me ask Mr. Thompson, because you have been 
involved in this type of legislation and you have heard the 
arguments against the disclosure requirement. You have reviewed 
the previous bill that I have introduced, and I think many 
companies were surprised at how small a disclosure requirement 
we actually have in H.R. 887. But from your looking at the 
changes which have been made in this bill, do you think any of 
those cost or burden arguments have been alleviated in the 
current legislation?
    Mr. Thompson. Yes, I think the changes from the prior 
legislation to this proposal speak to a number of concerns that 
were raised about cost and regulation.
    This bill is disclosure which is common in lots of areas of 
corporate America. Companies do it all of the time. It only 
applies to specific disclosures when there is a specific 
conflict. There will be a threshold which can speak to the 
numbers that you made in your opening statement. If you 
eliminate all the small ones, it is not a large number. With 
those changes, the burden has been made much smaller.
    Remember, the costs generally are not very great because 
the information is being collected to be given to the tax 
authorities relevant to tax returns. So I think that the 
changes have been very responsive to the concerns raised about 
the cost and impact.
    Mr. Gillmor. Thank you very much.
    The gentleman from California, Mr. Cox.
    Mr. Cox. Thank you, Mr. Chairman.
    I would like to thank our witnesses for being with us this 
morning, and I would like to thank Eaton for its enlightened 
policy. I think the reason that we are here this morning is to 
see whether or not Eaton's enlightened policy ought not to be 
the policy generally in a marketplace that is characterized by 
full disclosure.
    Mr. Mason, I think I share your concern about anything that 
would have a chilling effect. I think the chairman's question 
about whether your enlightened policy and disclosure causes any 
chilling effect gets right to the heart of it. In your view it 
does not, but there are certain kinds of transfers of 
shareholder wealth for no value--which is what a gift is, it 
has to be in return for nothing--that obviously could violate 
the fiduciary duty of the officer or director, that obviously 
could work to the personal benefit of the person making the 
transfer and so on.
    There are a number of reasons that I can think of that 
shareholders at least ought to have access to that information. 
And insofar as the link between officers and directors of the 
contributing corporation and directors of the nonprofit, it 
seems to me that is exactly the kind of information that 
shareholders are already entrusted with when it comes to other 
benefits to the directors and the officers of the company in 
which they invest.
    For example, I think I would make the same argument that 
you just made about the value of getting your officers or your 
board members involved in a charity that you are contributing 
to when it comes to stock options. You know, we give officers 
and directors stock options all of the time. There is a 
potential conflict of interest there, of course, but for the 
most part I think companies and management believe, and 
generally investors go along with this, that giving people who 
work there a stake in the outcome is a good idea. Yet our 
disclosure rules require us to disclose the hell out of this 
area to make sure that there is not a conflict of interest. 
That didn't stop companies from--do you have stock options?
    Mr. Mason. Yes, sir.
    Mr. Cox. You bet, and so do most corporate insiders. The 
fact that there is disclosure doesn't in any way chill the use. 
Why doesn't it chill the use of stock options?
    Mr. Mason. Well, Mr. Cox, I am not certain where we are 
going on this. We offer stock options to a lot of men and women 
within my company, not just the senior officers.
    Mr. Cox. But specifically, why does the fact that you have 
to disclose the details as an insider transaction, as it were, 
not deter you from doing it?
    Mr. Mason. It is a good point. We certainly do disclose 
that candidly in our proxy statement.
    Mr. Cox. By law?
    Mr. Mason. By law, on an aggregated basis. There are 
certain individuals with their compensation that are outlined.
    I think philanthropy and what we are talking about on stock 
options, although--I am not arguing with you. We chose to 
disclose. We choose to do that on a voluntary basis. I can 
understand some organizations not being particularly enamored 
with doing that, and I think you and I would know those types 
of organizations. I think if you can't stand the heat in this, 
you ought not to show your philanthropy.
    We are not going to make a major difference with our 
corporate philanthropy in health and human services across this 
country of ours. We think that we are trying to do those 
things, Mr. Cox, on the margin that might make a difference.
    Mr. Cox. You want to do your part?
    Mr. Mason. Yes, sir. And we would like to have those men 
and women who are employees of ours step up to that both from a 
volunteer standpoint, giving of their time and talent as well 
as some resources, as well as the company matching that 
activity. I think the centerpiece for our philanthropy has been 
our support of the United Way. For every dollar a man and woman 
who works for Eaton contributes, we put in 50 cents. And that 
doesn't sound like much until you start aggregating that pot 
and it is about $2.5 million that our employees give and we are 
doing about 50 percent of that. So aggregating, you are getting 
close to $4 million.
    Mr. Cox. I think it is going to be very hard for the four 
of us to disagree on most of these things because it is rather 
obvious that corporate contributions are made for the purpose 
of benefiting the general community of which business 
organizations find themselves a part. It is well understood 
that encouraging employees, management, directors, to 
participate in their communities is a good thing, makes them 
better workers, makes the community a better place. And it is 
all benign.
    The very reason that corporations make charitable 
contributions is that they wish to show themselves to be good 
corporate citizens, and they wish to be good corporate 
citizens. For that very reason, many corporations go out of 
their way to advertise their charitable involvements. The 
disclosure of those charitable contributions would as a result 
only further advertise what they already are proud of and what 
they want to take credit for and encourage more of.
    So what we are talking about here, if there is a chill at 
all, is chilling things that for some reason somebody that is 
part of the transaction would rather cover up, would rather 
keep a secret. And I wonder if I could ask, Mr. Thompson, what 
kinds of transactions are those?
    Mr. Thompson. They are basically conflict-of-interest 
transactions. Your point about not many companies not 
disclosing stock options is a strong one. Probably a few more 
disclose their charitable contributions because of the benefit 
that you just described of being a good corporate citizen, but 
not many do.
    The SEC study done at the request of the committee has a 
survey of the largest 100 corporations, and they tried to get 
the information from those companies about their charitable 
contributions and it was pretty hard to get the information. So 
there was some resistance to that. Where the resistance will be 
the most is where there is a specific conflict, a potential for 
embarrassment, and they don't want the embarrassment.
    Mr. Cox. Let us say that a company has a union and let us 
say that the company does not--at least its management does not 
wish to antagonize the union, but the company wants to 
influence legislation in Washington. Could the company make a 
contribution to a nonprofit organization which would then 
advertise against the union's position at arm's length and not 
disclose that to anybody?
    Mr. Thompson. The line between charity and business 
expenses is sometimes gray and hard to define, and your example 
might well fall into that gray area.
    Most of the stories and concerns which have been raised by 
charitable contributions have been more directly related to 
charity, but it would not exclude the example that you raised.
    Mr. Cox. Your concern is officers and directors using 
corporate assets to benefit themselves personally; is that what 
you think is the garden-variety abuse?
    Mr. Thompson. They are given the right how to decide to use 
other people's money, and that is done for corporate purposes. 
That discretion is sometimes used for charitable contributions 
which can be good. But when they get a personal benefit from 
that, we have crossed the line from the beneficial use to the 
use that should concern us. This legislation tries to disclose 
those examples.
    Mr. Cox. I take it because the character of the personal 
benefit is always going to be in the eye of the beholder--these 
are subjective judgments--that you would recommend that 
Congress make no attempt to actually regulate corporate gifts 
themselves, but rather simply use the disclosure model to let 
the market handle it?
    Mr. Thompson. Disclosure is the best police officer, and 
the market can decide for itself. I would expect that many 
corporations would present their charitable contributions the 
way that Mr. Mason has described what Eaton does; showing its 
commitment to volunteerism. But within that context, there will 
be the information for shareholders to evaluate whether or not 
directors are getting too close to the line.
    Mr. Cox. There is an unchallenged assumption here that it 
is the business of corporations in part to contribute money to 
their communities. There is another point of view. Milton 
Friedman once wrote, ``Few trends could so thoroughly undermine 
the foundation of our society as the acceptance by corporate 
officials of a social responsibility other than to make as much 
money for their stockholders as possible.'' Of course he 
fleshed out his reasons for saying that, and they are not 
trivial. We are not asking that question here this morning with 
the consideration of this bill because the bill essentially 
would state in law that this is an acceptable practice; but 
should we be concerned in any way at the margin about the 
license that this bill would give for corporate philanthropy 
which presently appears nowhere in the securities laws?
    Mr. Thompson. For much of this century which is now 
closing, the law has not permitted those kinds of charitable 
contributions by corporations. It has been an evolution over 
the last few decades of this century to where that has been 
permissible. There is an argument against that which you have 
identified and addressed.
    The Congress could if it wished take up that point. That is 
more likely a question for state corporate law than Federal 
securities laws. The reason that it is relevant for Federal 
securities laws is that disclosure is the main focus of Federal 
law and this bill picks up on that disclosure aspect and says 
disclose what you are doing within the bounds of State law.
    Mr. Cox. But you are the law professor and I am not. It is 
my understanding that there is nothing in the 1933 act or the 
1934 act or the Investment Company Act today that in any way 
acknowledges that it is an appropriate mission of the 
corporation to give away money for no value?
    Mr. Thompson. No.
    Mr. Cox. So this would be the first time that we are 
stating in statute that is okay?
    Mr. Thompson. It is saying that if it happens, it needs to 
be disclosed.
    Mr. Cox. I don't think that you would task the SEC with the 
business of drafting regulations to determine at what threshold 
corporate contributions are being made if it were verboten.
    Mr. Thompson. I think that is a fair statement, yes, sir.
    Mr. Cox. I just observe, Mr. Chairman, that ought to at 
least counterbalance, or more, concerns about chilling effects 
because this is the first time that Congress would be saying 
that this is an acceptable use of corporate funds and there are 
arguments that it is not.
    I thank the chairman.
    Mr. Gillmor. Thank you very much, Mr. Cox. That will 
conclude our first panel and the hearing on H.R. 887. We will 
ask--I want to thank both of you, Mr. Thompson and Mr. Mason, 
for coming and helping us out.
    We will ask our second panel to come forward.
    Let us begin with opening statements. Congressman Markey 
who is a cosponsor of this bill, H.R. 1089, has made an opening 
statement.
    Let me say that similar to mutual fund costs, most 
investors in nontax-deferred accounts do not understand how 
taxes impact total return, and most fund shareholders probably 
don't give much weight to tax considerations.
    I would like to thank the chairman of the subcommittee, 
Chairman Oxley, and the ranking member, Ed Towns, for joining 
me in cosponsoring the legislation I have introduced, as has 
Mr. Markey.
    This is an effort to provide millions of American 
shareholders relevant information regarding their financial 
objectives. I want to applaud the mutual fund industry for 
giving Americans an easy way to participate in American 
capitalism and for the enlightened view that they have by and 
large taken toward more disclosure of pre- and after-tax 
returns. If you look at the chart, you can see the impact that 
taxes have had on mutual fund returns. We have heard about the 
magic of compounding, but the magic of compounding doesn't 
discriminate. It works equally well with costs and taxes as it 
does with return.
    The yellow bar shows a rate of return before taxes of the 
average mutual fund over the 15-year period ending June 30, 
1998 and that was 13.6 percent.
    The subcommittee held a hearing last fall on mutual fund 
fees and expenses, and the red bar represents the return of the 
average mutual fund after fees and expenses. And that is a 
return that is disclosed to fund shareholders. The majority of 
fund assets are in nontax-deferred accounts, and investors owe 
taxes on the distribution a fund makes.
    The blue bar represents the total return shareholders get 
after they pay taxes, and based on the market return over a 15-
year period, the average tax return or the average mutual fund 
represents only 67 percent of the pretax return that is 
disclosed to fund shareholders.
    If the average annual return continues for another 5 years, 
a $10,000 initial investment in the market would have grown to 
$208,000. After costs and expenses, that $208,000 is reduced to 
$128,000. Finally, after taxes, the shareholder is left with 
just $75,000 or just 36 percent of the total market return. In 
other words, over 20 years the investor loses $133,000 to costs 
and taxes.
    So after taxes, the rate of return for the average mutual 
fund fell to 10.8 percent. And at the end of the 15-year 
period, the after-tax return is only 69 percent of the pretax 
return.
    It is clear that many mutual fund investors and managers 
focus only on investment performance before costs and taxes. As 
taxes are just an added cost to investors, fund shareholders 
should have an opportunity to judge a fund manager's trading 
activities to see how it impacts taxes.
    Since we are talking here about taxes primarily derived 
from the stock market, here is what I think is an interesting 
figure. The Federal Government collected over $23 billion in 
taxes off mutual fund trading last year. Now if that were the 
only source of income for the U.S. Government, the United 
States would rank 150th on the Fortune 500 list based on 
revenues and we would be just ahead of Walt Disney and Coca-
Cola.
    Are some mutual fund income and capital gains distributions 
inevitable? Of course they are. Likewise, many are preventable 
as well. If minimizing taxable income is not important to the 
fund manager, it certainly is to the shareholder. A tax is a 
cost, and to the extent that taxes can represent as much or 
more than the cost of managing the mutual fund, I think 
investors should be provided this information in a form that is 
easily understood. Shareholders incur taxes when a fund makes 
income or capital gains distributions. When it sells 
securities, realizes a profit, capital gains are incurred and 
distributed, and the selling of those securities is a result of 
portfolio management decisions. And fund shareholders should be 
afforded the opportunity to review what the tax liability is 
that is going to be imposed on them.
    Now, this bill does not in any way tell a fund manager 
when, what, or how frequently to buy or sell. It simply 
discloses the tax consequence of those actions.
    I am encouraged by the efforts of the members of this panel 
and by the mutual fund industry to improve after-tax disclosure 
to shareholders. The Investment Company Institute has stated 
its support for the bill's objectives, and I am confident that 
we will continue to work together in the best interest of 
shareholders.
    Our panel consists of Joel Dickson, Senior Investment 
Analyst of Vanguard Group; Mr. David Jones, Vice President, FMR 
Company, the Fidelity Mutual Fund Group; and Matthew Fink, the 
President of the Investment Company Institute, and we will 
begin with Mr. Dickson.
    First, I want to ask Mr. Cox if he has an opening statement 
on this legislation.
    Mr. Cox. I do not. I am anxious to hear from the witnesses.
    Mr. Gillmor. You may proceed, Mr. Dickson.

   STATEMENTS OF JOEL M. DICKSON, SENIOR INVESTMENT ANALYST, 
 VANGUARD GROUP; DAVID B. JONES, VICE PRESIDENT, FMR CO.; AND 
    MATTHEW P. FINK, PRESIDENT, INVESTMENT COMPANY INSTITUTE

    Mr. Dickson. Thank you, Mr. Chairman and members of the 
subcommittee. I welcome the opportunity to testify today on the 
Mutual Fund Tax Awareness Act of 1999. The Vanguard Group 
strongly supports the bill's objective of providing better 
information on the actual return of mutual funds for taxable 
investors. To date, most investors have little or no idea about 
how taxes reduce their returns because the industry generally 
has not discussed the tax implications of mutual fund 
management.
    Taxes are the largest cost of mutual fund investment for 
most investors. Based on calculations from Morningstar, the 
average domestic equity fund returned about 13.5 percent 
annually on a pretax basis over the last 10 years. However, 
these funds returned about 11 percent on an after-tax basis, a 
difference of 2.5 percentage points per year.
    In fact, two funds with identical pretax returns can have 
very different after-tax returns. For example, a $10,000 
investment in Vanguard Growth and Income Fund would have grown 
to about $47,700 over the last decade, about $1,000 more than 
in the Vanguard 500 Index Fund. However, on an after-tax basis, 
the index fund's total of $42,100 was some $4,600 higher. 
Vanguard has long encouraged investors to become more 
knowledgeable about the tax costs of investing. Most recently 
we began publishing after-tax mutual fund returns. We are the 
first mutual fund company to report after-tax returns for funds 
other than those that present themselves as tax managed. This 
is an important step because tax-managed funds represent less 
than 1 percent of industry assets. We believe that our new 
disclosure is in lockstep with the objectives of the bill being 
discussed today.
    I would like to highlight one important aspect of our 
calculation. We calculate the return by accounting for the 
taxes paid on distributions made by the fund to its 
shareholders. The primary advantage of this approach is that it 
isolates the tax effects on all shareholders resulting from the 
portfolio manager's decisions.
    An alternative would be to assume a shareholder sells his 
or her fund shares and pays all the taxes. Because this is an 
individual decision affecting a particular shareholder, it does 
not help investors understand how the manager's decisions 
affect performance. Vanguard believes that our calculation 
allows for a clear-cut discussion of after-tax returns without 
potentially confusing shareholders.
    It is important to note that our after-tax calculation or 
any after-tax calculation for that matter, is not intended to 
represent the exact investment return for any particular 
investors. Every individual's return will differ based on his 
or her unique tax situation. Rather, our intent is to allow for 
relevant comparisons of tax effects across mutual funds with 
similar objectives.
    Although certain assumptions must be made to compute an 
after-tax return, Vanguard believes that we have developed a 
presentation that gives relevant, useful information that the 
average investor can understand. Our annual report disclosure 
closes an important gap in the assessment of a fund's return 
and speaks directly to the goals of The Mutual Fund Tax 
Awareness Act of 1999. To the extent that others think that our 
methodology or presentation can be improved, we would welcome 
their input. Thank you very much.
    [The prepared statement of Joel M. Dickson follows:]
 Prepared Statement of Joel M. Dickson, Principal, The Vanguard Group, 
                                  Inc.
    I welcome the opportunity to testify today on the Mutual Fund Tax 
Awareness Act of 1999 and appreciate your invitation for me to address 
this topic. Vanguard strongly supports the bill's objective of 
providing to mutual fund shareholders better information on the actual 
return of their funds.
                 the tax cost of mutual fund management
    Taxes are the largest cost of mutual fund investment for most 
investors. Based on calculations using data from Morningstar, the 
average domestic equity mutual fund has lost nearly 2.5 percentage 
points per year to taxes on distributions of dividends and capital 
gains made to the fund's shareholders. Unfortunately, most investors 
have little or no idea about how taxes reduce their returns because the 
industry generally does not discuss the tax implications of mutual fund 
management.
[GRAPHIC] [TIFF OMITTED] T1039.001

    If every fund lost the same amount to taxes each year, then 
little useful information would be gained by reporting after-
tax returns. However, funds vary tremendously in the tax 
burdens they place on their shareholders. For this reason, 
pretax returns can be misleading for shareholders subject to 
taxes on the distributions they receive. Although the average 
annual tax bite was 2.5 percentage points, the amount lost to 
taxes for an individual fund ranged from zero (that is, the 
pretax and after-tax returns were equal) to 7.35 percentage 
points per year.
    Rankings of funds' returns also differed greatly depending 
on whether pretax or after-tax returns are used. Of the 547 
domestic equity funds with 10 years of returns, 118 (22%) would 
have their rankings change by more than 10 percentile points--
i.e., they moved up or down by at least 55 spots in the 
rankings--depending on whether they were being evaluated on 
pretax or after-tax returns. The differences can be startling. 
The fund that lost the most to taxes each year ranked 28th on a 
pretax basis, yet fell to 272nd out of 547 funds on an after-
tax basis.
    Similarly, two funds that may appear identical on a pretax 
basis can have very different after-tax returns. As shown in 
the chart below, Vanguard Growth and Income Fund outperformed 
Vanguard 500 Index by a slight margin over the past ten years 
on a pretax basis. However, after considering taxes, the 500 
Index Fund would have generated a substantially higher return. 
In other words, an investor in a tax-deferred vehicle--e.g., a 
401(k) or Individual Retirement Arrangement--would have been 
better off with the Growth and Income Fund. The taxable 
investor, on the other hand, would have accumulated greater 
wealth with the 500 Index Fund.
[GRAPHIC] [TIFF OMITTED] T1039.002

    Performance reporting that considers only pretax returns could lead 
taxable investors to believe that the past performance of a particular 
fund was much better than it actually was for a taxable shareholder. 
Because of these substantial differences in pretax and after-tax 
returns, we believe that after-tax returns should be reported in 
prospectuses or shareholder reports.
   vanguard's efforts to educate shareholders on mutual fund taxation
    Vanguard has long encouraged investors to become more knowledgeable 
about the tax costs of investing. Most recently, we began publishing 
after-tax returns in the annual reports of our equity and balanced 
mutual funds. In total, these initiatives represent a natural evolution 
of Vanguard's long-standing leadership position in providing clear and 
candid disclosure on issues that investors should understand when 
evaluating funds' performance. Some other examples of Vanguard's 
efforts to communicate the importance of taxes on mutual funds' returns 
include:

 developing a free, educational booklet, ``Taxes and Mutual 
        Funds,'' that describes the tax consequences of mutual fund 
        investment;
 adding voluntary disclosure to our prospectuses regarding the 
        portfolio manager's sensitivity to tax implications when making 
        trading decisions. In most cases, our actively managed equity 
        funds are managed for pretax return. In these cases, our 
        prospectuses state that ``this fund is generally not managed 
        with respect to tax ramifications'';
 launching five ``tax-managed'' funds that are offered only to 
        taxable shareholders and publishing after-tax returns for these 
        funds in the 1998 annual report to shareholders; and
 reporting estimated dividend and capital gain distributions 
        well in advance of distribution dates so that shareholders can 
        assess the impact of purchasing shares before the distribution, 
        which might accelerate their tax liability.
           vanguard's initiative to report after-tax returns
    Earlier this month, Vanguard announced that we would start 
reporting after-tax returns in the annual reports of all of our 
balanced and equity mutual funds. Vanguard decided to publish after-tax 
returns for a broad range of funds after considering a number of 
options. Calculating and presenting after-tax returns raise a number of 
challenges, including what methodology to use and how to explain the 
returns to shareholders in a clear and concise manner. Ultimately, we 
believe that we succeeded in developing disclosure that meets the 
objectives of providing relevant, useful information that the average 
investor can understand. An example of our disclosure is presented on 
the following page.
[GRAPHIC] [TIFF OMITTED] T1039.003

[GRAPHIC] [TIFF OMITTED] T1039.004

    We believe our new disclosure is in lockstep with the objectives of 
the bill being discussed today, and I would like to highlight a few key 
points of our presentation. We made a conscious decision to publish 
after-tax returns in the annual reports only for balanced and equity 
funds and not for bond and money market funds. We view the annual 
report as the appropriate venue to discuss the impact of the investment 
adviser's decisions on investment returns. As previously documented, 
tax realizations vary greatly among equity funds because capital gain 
realizations resulting from the sale of stocks are largely at the 
discretion of the portfolio manager. On the other hand, there is little 
ability for bond fund managers to affect the relative after-tax returns 
of their funds because interest income received from a bond investment 
is not an event that can generally be controlled by the manager. 
Although we feel that a discussion of bond funds' after-tax returns 
does not warrant discussion in the annual reports, we do make these 
returns available through other media (e.g., over the phone or on our 
website) for shareholders seeking such information.
Overview of Vanguard's After-Tax Calculation Methodology
    Our calculation of after-tax returns makes the following key 
assumptions:

 After-tax returns are calculated by reinvesting all of the 
        fund's distributions made to shareholders, less any taxes owed 
        on such distributions. (Pretax returns are computed by 
        reinvesting the entire distribution.) In other words, taxes are 
        owed at the time of the distribution.
 We use historical tax rates in the computations. Specifically, 
        we use the highest individual federal income tax rates in 
        effect at the time of the distribution (currently 39.6% for 
        dividends and short-term capital gain distributions and 20% for 
        long-term capital gain distributions). We make no adjustments 
        for state or local income taxes.
 We assume that the fund shares were retained--not sold--at the 
        end of the periods shown.
Pre-Liquidation vs. Post-Liquidation Returns
    The most important assumption is that we assume no liquidation of 
the fund's shares at the end of the measurement period. This approach 
may understate the total taxes due for a shareholder who may ultimately 
redeem his or her investment and pay additional taxes upon such a sale. 
The primary advantage of the preliquidation figure is that it isolates 
the effects on all shareholders of the taxes resulting from the 
portfolio manager's investment decisions. That is, distribution of 
dividends and capital gains result from the fund's portfolio management 
activity and are given to all shareholders based on their pro-rata 
share of the fund's holdings.
    An alternative methodology would be to assume a liquidation of the 
fund's shares at the end of the period, whether or not a shareholder 
would actually redeem his or her investment. In contrast to the 
preliquidation figure, this method tends to overstate the tax impact of 
mutual fund investments because it accelerates the tax liability for 
the buy-and-hold investor. More importantly, the sale of fund shares is 
an individual investment decision that results in a taxable event for a 
particular shareholder. It does not help investors understand how the 
manager's decisions affected the tax liability of all shareholders in 
the fund. Given these considerations, Vanguard believes that a pre-
liquidation calculation is the best approach to assess how a manager's 
actions affect the after-tax returns received by shareholders.
Using the Highest Federal Marginal Tax Rates
    By incorporating the highest individual federal income tax rate in 
effect at the time of the distribution, we are taking the most 
conservative approach by illustrating the greatest potential tax impact 
to total return. While this methodology will

not incorporate the marginal tax brackets of all our taxable 
shareholders, it will ensure that the impact of taxes is not 
understated for an individual taxable investor. (We do not incorporate 
state and local taxes because of the significant complexity in 
calculation and presentation that would result in presenting returns 
for all 50 states and the District of Columbia.)
    It is important to note that our after-tax calculation is not 
intended to represent the exact investment return for any particular 
investor because every individual's return will differ based on his or 
her unique tax situation. Rather, our intent is to allow for relevant 
comparisons of tax effects across mutual funds with similar objectives. 
Vanguard's methodology is the same used by Morningstar in their after-
tax return calculations, which allows investors to make an ``apples-to-
apples'' comparison between a Vanguard fund's after-tax returns and an 
appropriate peer-group average after-tax return.
    That said, we realize that most shareholders do not fall within the 
highest federal marginal tax rate bracket--currently 39.6%. However, 
the difference between after-tax returns using the highest rate versus 
a more-common rate of 28% would be less than 0.4 percentage points 
annually for most of Vanguard's equity funds over the last ten 
years.\1\
---------------------------------------------------------------------------
    \1\ This relatively small difference in after-tax returns between 
the 28% and 39.6% tax rates occurs because the tax rate difference 
applies only to dividends and short-term capital gains. Over the past 
ten years, long-term capital gains have been taxed at the same rate 
(28% prior to the spring of 1997 and currently 20%) for all taxpayers 
outside of the lowest federal tax bracket. Among Vanguard's equity 
funds, long-term capital gains have generally represented the bulk of 
the taxable distributions.
---------------------------------------------------------------------------
    Given this modest difference in returns, we decided to use the 
``highest rate'' methodology because it is the most conservative 
approach and because it is much simpler to track the ``highest rate'' 
over time, rather than trying to determine what historical tax rates 
would correspond to today's tax brackets. We believe that it is 
extremely important to use historical tax rates in the calculation in 
order to capture any tax-related portfolio management decisions made as 
a result of anticipated tax rate changes.
                                summary
    You will undoubtedly hear arguments that computing after-tax 
returns is a complicated endeavor that may lead to such confusion among 
investors that the information could do more harm than good. Although 
certain assumptions must be made to compute an after-tax return, we 
think these issues can be addressed without sacrificing either the 
relevance of the calculation or the clarity of the presentation. In 
fact, Vanguard has taken up this challenge, and we believe that we have 
developed clear, concise disclosure on the after-tax performance of our 
balanced and equity mutual funds. Our annual report disclosure closes 
an important gap in the assessment of a fund's return and speaks 
directly to the goals of the Mutual Fund Tax Awareness Act of 1999. To 
the extent that others think that our methodology or presentation can 
be improved, we would welcome their input.

    Mr. Gillmor. Thank you, Mr. Dickson.
    Mr. Jones.

                   STATEMENT OF DAVID B. JONES

    Mr. Jones. Thank you, Mr. Chairman and members of the 
subcommittee. I appreciate the opportunity to testify before 
you today regarding H.R. 1089, the Mutual Fund Tax Awareness 
Act of 1999. Fidelity Investments supports the bill's goal of 
providing investors with access to better after-tax return 
information for their funds. We believe investors would benefit 
from having a better understanding of the impact of taxes on 
their investments and from the development of an industry 
standard calculation which would allow relevant comparisons 
across different mutual funds.
    We note in this respect that mutual funds as a group are 
relatively tax efficient investments compared to many other 
alternatives available to investors because in contrast to an 
investment such as a certificate of deposit or a Treasury bill 
which bears interest, mutual funds are allowed to provide 
investors with returns taxable at more favorable long-term 
capital gain rates and not all of this necessarily is taxable 
in any given year.
    Now, Fidelity first published after-tax returns for one of 
its funds in 1993, and we have developed an approach to 
calculating after-tax returns that we believe presents the 
impact of taxes fairly and accurately to investors. We have 
shared that approach with the SEC and have met with them on 
several occasions at their request to discuss some of the 
issues associated with this, and some of the very detailed 
matters of how the calculation works. But overall, the approach 
that we have developed is very similar to the approach 
developed by other industry members and analysts of the 
investment company community.
    Nevertheless, there are some important details and 
differences that remain to be resolved.
    Now any standardized return calculation does require a 
number of assumptions because investors have so many different 
tax positions individually. Possibly the most useful figure is 
to assume an individual investor in the highest tax bracket 
since that maximizes the tax impact, but inevitably this will 
be an inaccurate number for those investors in lower brackets, 
and importantly, for the very large number of investors who 
invest through retirement plans and are subject to completely 
different tax regimes.
    After-tax returns also vary depending on whether you have 
presumed the investor continues to hold the account, so-called 
preliquidation return, or if you assume that the investor 
redeems their shares and uses the money for some purpose, a 
post-liquidation return.
    Preliquidation returns will highlight the impact of 
dividends and distributions that an investor receives during 
the course of their holding period, but doesn't take all tax 
liabilities into account because some capital gain liability 
remains upon redemption.
    As a result, preliquidation returns will tend to be higher. 
Post-liquidation returns are, after all, taxes, including 
anything due when the shares are redeemed, and including any 
exit fees that may be imposed by the fund company. This is 
consistent with the approach currently required by the SEC for 
pretax total returns. We feel that this gives a more realistic 
impression of tax impact for investors, particularly over 
longer time periods.
    Now since 1993 our approach has been to show both of these 
numbers to investors because we believe that it is essential to 
see the two of them to truly understand the tax impact. 
Relative results can differ. A fund that appears to be have a 
superior return on a preliquidation basis may have an inferior 
return on a postliquidation basis, and vice versa. That is an 
important point. There are some examples of that in my written 
testimony.
    So finally, I conclude by noting that the competing methods 
that we have of after-tax return calculation in the industry 
are very similar to each other, and this suggests that this 
forms a very sound basis for developing an industry standard. 
The next step is to hammer out some very important details and 
some philosophical questions ultimately to be arbitrated by the 
SEC so that we can have a consistent industry standard that is 
efficient for mutual fund companies to produce an effective 
tool for communicating to investors.
    Thank you.
    [The prepared statement of David B. Jones follows:]
    Prepared Statement of David B. Jones, Vice President, Fidelity 
                     Management & Research Company
                            i. introduction
    My name is David B. Jones. I am Vice President of Fidelity 
Management & Research Company, the investment advisor to the Fidelity 
Investments group of mutual funds.1
---------------------------------------------------------------------------
    \1\ Fidelity Investments manages more than 280 funds with more than 
15 million shareholders. With total assets under management of more 
than $833 billion, Fidelity is the largest mutual fund manager in the 
United States. Fidelity also makes more than 4,000 non-Fidelity funds 
available to investors through its FundsNetwork program.
---------------------------------------------------------------------------
    I appreciate the opportunity to testify today on H.R. 1089, the 
``Mutual Fund Tax Awareness Act of 1999''. This bill, which has been 
introduced by Representatives Gillmor, Markey and nine cosponsors, 
would direct the Securities and Exchange Commission (``SEC'') to 
develop a requirement pursuant to which mutual funds would disclose the 
effects of taxes on returns to fund investors.
    Fidelity Investments supports the bill's goals. We believe that 
investors would benefit from having access to after-tax return 
information for the funds they invest in; that the fund industry would 
benefit from having an industry-standard formula for after-tax returns, 
so that investors can compare funds on an equivalent basis; and that 
ultimately all would benefit from having better information available 
about the impact of taxes on fund returns. The mutual fund industry has 
built its success on providing investors with the education and the 
tools they need to invest responsibly. After-tax returns are one more 
tool that investors can use to gain a better understanding of the 
investment world and of their financial future.
    In addition, we are mindful of the fact that mutual funds as a 
group are relatively tax-efficient investments compared to many other 
investment and savings alternatives. For example, savings accounts, 
certificates of deposit and even U.S. Treasury bills all generate 
returns that are 100% taxable, at ordinary income rates, in each year 
as the returns are earned. Mutual funds, by contrast, may generate 
returns that are wholly or partly taxable at more favorable long-term 
capital gain rates, and may allow investors to defer taxes on part of 
their returns until they liquidate (redeem) their investments. 
2
---------------------------------------------------------------------------
    \2\ The tax benefits of mutual funds compared to other investments 
can be dramatic. An investor who bought our Fidelity OTC Portfolio on 
September 30, 1998 would have earned a 52.10% pretax return through 
September 30, 1999. After paying taxes on fund distributions, an 
individual investor in the top tax bracket would still have had a 
48.86% return, which represents 94% of the pretax result. And after 
liquidating the investment and paying all remaining capital gains taxes 
(assuming long-term gain rates), the investor would have had an after-
tax return of 40.87%, or 78% of the pretax return. (Source for returns: 
Morningstar Inc.) If that 52.10% return had been earned from another 
type of investment in the form of interest, the investor's after-tax 
return would have been 31.47%, or only 60% of the pretax result, 
because 39.6% of the return would have gone to pay federal taxes.
---------------------------------------------------------------------------
    Fidelity Investments first published after-tax returns in 1993, in 
annual and semiannual reports for a Fidelity bond fund managed for 
after-tax results. Although that fund has since been liquidated, today 
we continue to publish after-tax returns for Fidelity Tax-Managed Stock 
Fund, which also is managed with after-tax results as an explicit goal.
    In the years since 1993 we have developed a methodology for 
calculating after-tax returns that we believe fairly communicates the 
impact of taxes on a shareholder's investment. Other fund complexes, 
working independently, have developed competing methodologies, as has 
Morningstar, Inc. the well-known third-party analysis firm. While the 
methodologies developed by Fidelity, Morningstar and other firms are 
remarkably similar in many respects, important differences of opinion 
remain. There are still essential details and complex technical 
questions that will fall to the SEC to resolve.
    Fidelity is prepared to do its part to help arrive at an industry 
standard for after-tax returns. We have met with the staff of the SEC 
on two occasions in 1999 to share our experiences on this subject, and 
have submitted to the staff, at their request, a letter outlining 
potential methodologies for calculating standardized after-tax returns 
for mutual funds.
    The remainder of my testimony discusses aspects of the after-tax 
return calculation methodology that Fidelity employs. Some of the more 
detailed aspects of that methodology, and some of the remaining open 
issues, are discussed in our letter to the SEC staff, a copy of which 
is attached as Exhibit 1.
      ii. major assumptions needed to calculate after-tax returns
    After-tax returns are inherently more complicated than pre-tax 
returns, because each investor has a different tax situation. Some may 
be in high tax brackets and be very sensitive to taxes, while some may 
be in lower brackets and be relatively unconcerned. Some investors are 
not subject to individual tax rates at all: corporations, for example, 
or offshore investors. Most importantly, many investors buy shares 
through tax-deferred retirement plans, and will not be subject to any 
taxes on their investments until some time in the future. Tax-deferred 
retirement accounts represent more than 50% of most Fidelity funds' 
shareholder base by assets.
    No one method can give the right after-tax result for all of these 
investors. As with any standardized calculation, inevitably the results 
will highlight one set of circumstances at the expense of others.
    In providing after-tax returns for our tax-managed funds, we have 
chosen to calculate results for an individual investor in the highest 
marginal tax bracket. This choice implies several limitations: among 
other things, it will overstate the impact of taxes for many investors, 
because most are not in the highest tax bracket, and it will produce an 
inaccurate result for retirement investors, because they are subject to 
a different tax regime. However, this choice of tax rates is useful as 
a way of highlighting the impact of taxes for the most tax-sensitive 
investors.
    Other assumptions and choices that must be made in developing a 
standard return include: whether to reflect state taxes (we do not), 
whether to use current tax rates or historical tax rates for historical 
periods (we prefer historical rates), when to assume that taxes are 
paid (we reflect them at the time that distributions are made, though 
others have suggested December 31 or April 15 of each year as an 
alternative), and how to handle special kinds of mutual fund 
distributions, such as returns of capital or distributions derived from 
real estate investment trusts. These assumptions will have a less 
material effect than the choice of a tax bracket, but they must still 
be resolved in a standard way for returns to be comparable across 
different funds.
           iii. pre-liquidation and post-liquidation returns
    ``Pre-liquidation'' returns are adjusted for taxes resulting from 
fund distributions--dividends, capital gains distributions, and other 
payments that funds make to their shareholders. Pre-liquidation returns 
do not reflect any taxes that may be due when an investor redeems his 
or her investment. We sometimes describe them as ``your after-tax 
return if you continued to hold your shares.''
    We quote pre-liquidation returns for our tax-managed fund because 
current income is of great concern to tax-sensitive investors, and pre-
liquidation returns highlight this aspect of mutual funds best. But 
because pre-liquidation returns do not reflect the taxes due upon 
redeeming shares, they can give a false picture of the impact of taxes 
on mutual fund investments: they are ``after-tax'' in a sense, but not 
after all taxes.
    At current federal tax rates, at least 20% of an investor's gains--
the most favorable tax rate available to investors in the maximum 
bracket--will ultimately go to taxes (unless the investor dies before 
touching the money, or donates his or her shares before death). Pre-
liquidation returns risk fostering the impression that taxes can be 
deferred indefinitely, which is not the case for most investors, and 
tend to exaggerate the benefits of tax deferral. As a result, we use 
them only in conjunction with ``post-liquidation'' returns, which 
reflect taxes due when the investment is reduced to cash that an 
investor can use. We sometimes describe post-liquidation returns as 
``your after-tax return if you closed your account.''
    Post-liquidation returns address other important disclosure 
concerns as well. Under current SEC requirements for pre-tax returns, 
funds must quote performance net of all exit fees or other charges (if 
any) that apply when a shareholder liquidates his or her investment. 
Pre-liquidation returns would not ordinarily reflect such charges, and 
thus could overstate performance. In addition, current SEC standards 
require funds to quote pre-tax returns for 1, 5 and 10-year holding 
periods. While a one-year period is relatively short, most mutual fund 
investors are likely to sell at least some of their shares before ten 
years are up, suggesting that a post-liquidation return may be the more 
relevant number.
    For all these reasons, we feel compelled to quote post-liquidation 
returns as well as pre-liquidation returns, even though post-
liquidation returns are normally lower numbers. However, this is a 
question on which reasonable parties may disagree, and it represents 
one of the areas where we expect further debate as the SEC decides on 
specific requirements.
                    iv. example of after-tax returns
    To illustrate the impact of after-tax return calculations, the 
following table compares the returns of Fidelity OTC Portfolio, an 
aggressive, actively managed stock fund focused on the over-the-counter 
market, and Fidelity's Spartan U.S. Equity Index Fund, a fund managed 
to track the S&P 500 index, for periods ended September 30, 1999. The 
index fund has generally had lower taxable distributions, because of 
its less active management style. However, the relative after-tax 
result depends both on the time period chosen and on whether returns 
are viewed before or after liquidation (the higher result in each case 
is in bold) 3.
---------------------------------------------------------------------------
    \3\ Source: Morningstar Inc., assuming maximum individual tax 
rates. For these funds Morningstar's calculation methodology is 
essentially the same as that used by Fidelity currently, except that 
their one-year post-liquidation returns assume long-term rather than 
short-term capital gain tax rates apply.

                              [In percent]
------------------------------------------------------------------------
                                                         Index     OTC
                                                          Fund     Fund
------------------------------------------------------------------------
One-year results:
Pretax................................................    27.54    52.10
Pre-liquidation.......................................    26.87    48.86
Post-liquidation......................................    21.74    40.87
Five-year results (annualized):
Pretax................................................    24.76    25.40
Pre-liquidation.......................................    23.65    22.30
Post-liquidation......................................    20.50    20.08
Ten-year results (annualized):
Pretax................................................    16.51    18.06
Pre-liquidation.......................................    15.26    14.84
Post-liquidation......................................    13.61    13.75
------------------------------------------------------------------------

    This example highlights the importance of considering both pre-
liquidation and post-liquidation results when considering historical 
after-tax returns. The example demonstrates that after-tax returns tend 
to be lower than pre-tax returns, and that post-liquidation returns 
tend to be lower than pre-liquidation returns. The 5-year results 
exemplify how a fund may have a superior pre-tax performance but an 
inferior after-tax return. And the 10-year results show how a fund may 
have a return that appears superior when viewed on a pre-liquidation 
basis, but inferior when viewed in terms of post-liquidation results.
                             v. conclusion
    The mutual fund industry has a long history of working with its 
regulators in developing standards for disclosure to investors. When 
the SEC developed standard calculations for mutual fund yields and 
total returns in the 1980s, they received substantial input from the 
industry and others, and took this input into account in designing 
final rules. As a result of this thorough, detailed process, the 
standard calculations promulgated in the 1980s still work well today.
    After-tax return calculations present a similar challenge. Industry 
members, working independently, have developed calculation 
methodologies that are similar in approach, suggesting that a standard 
calculation may be within reach. But important details remain to be 
resolved in order to assure that after-tax return calculations will be 
efficient for funds to produce and effective in communicating to 
investors. We look forward to working with other industry members and 
the SEC to develop effective standards.
    Fidelity Investments appreciates the opportunity to testify before 
the Subcommittee. We support the objectives of the ``Mutual Fund 
Awareness Act of 1999''. We will continue to work with the Congress and 
the SEC in order to achieve after-tax measurements that will be most 
useful to our shareholders.
                               Exhibit 1
                                                      4 August 1999
Susan Nash, Esq., Senior Assistant Director
Division of Investment Management
Securities and Exchange Commission
450 5th Street, N.W.
Washington, DC 20549

Re: Sample Calculation Methodology for Mutual Fund After-Tax Total 
Returns

    Dear Ms. Nash: As you requested by phone, we have drafted a set of 
sample instructions for calculating mutual fund after-tax returns. The 
instructions are based on the calculation methodology we used in 
calculating after-tax returns for two of our funds that have tax 
management as an explicit investment goal: Spartan Bond Strategist, 
which operated from 1993 through 1996, and Fidelity Tax-Managed Stock 
Fund, which commenced operations in November 1998.
    The sample instructions (enclosed) are designed to produce after-
tax returns that would complement standard pre-tax returns calculated 
under Item 21(b)(1) of Form N-1A. As a result, they follow the same 
basic assumptions as those standard return calculations, including the 
assumption of a hypothetical $1,000 one-time initial investment and 
deduction of all sales loads and other charges, and assume that after-
tax returns would be calculated on an annualized basis for 1-, 5- and 
10-year periods. Similar tax adjustments could also be applied to other 
kinds of total returns (such as no-load returns, returns assuming a 
series of periodic investments, or returns for alternative time 
periods) with equal validity. As you requested, we have supplied 
instructions for pre-liquidation and post-liquidation after-tax 
returns.
    As we have discussed, there is no one after-tax calculation that 
will be meaningful for all investors, because their tax situations can 
differ so dramatically. Therefore, we necessarily made a number of 
assumptions in calculating after-tax returns for our tax-managed funds, 
which are reflected in our sample instructions. They include the 
following:
    1. Individual Tax Rates. We assumed tax rates for individuals, and 
assumed shares were held outside a tax-deferred account. A corporate 
investor, or an individual buying through a retirement plan, would have 
significantly different results: our calculation would not produce an 
after-tax return that would apply to them.
    2. Historical Tax Rates. We believe that historical tax rates 
produce a more accurate result than current tax rates, although this 
method requires a rule for selecting historical tax brackets (we have 
supplied one possible rule, based on assuming a constant wage adjusted 
for inflation). We have not specified a particular tax bracket in the 
instructions; for our tax-managed funds, which were designed for 
higher-bracket investors, we used the maximum tax bracket, but this may 
be too high a rate for the more typical fund investor. We have also 
assumed deduction of federal taxes only, in order to produce a number 
that could be useful for investors in multiple states, and have not 
attempted to include the impact of the federal alternative minimum tax, 
which only applies to some taxpayers.
    3. Time of Deemed Tax Payment. We have assumed that taxes on 
distributions are paid at the time of the distribution, as if they were 
withheld from the distributions before reinvestment. Although other 
methods could be imagined (redeeming shares from the account to pay 
taxes on December 31 or April 15, for example, or assuming taxes are 
paid from some separate cash account), we believe this method is the 
simplest and involves the fewest assumptions.
    4. Special Distribution Characteristics. In addition to ordinary 
income dividends and capital gain distributions, funds may have 
distributions or other features with more complicated tax consequences. 
These may include distributions taxable as returns of capital, 
distributions that are partially derived from municipal interest and 
therefore are partially tax-free, distributions derived from REIT 
income (i.e., recaptured depreciation) taxable at a special 25% rate, 
distributions derived from commodities gains taxable at 28%, retained 
capital gains taxable at the fund level, and foreign tax credits or 
deductions that pass through with respect to foreign source income. 
Rather than enumerate how each of these should be handled in an after-
tax return calculation, we have tried to describe more general 
principles under which these events would be taken into account based 
on their impact on an individual taxpayer.
    5. Gains or Losses on Redemption. Taxes on capital gains are 
assumed to reduce ending value (and after-tax return), while losses on 
redemption are treated as a tax benefit that increases after-tax 
return. In effect, the calculation assumes that capital losses can be 
used to offset capital gains of the same character (long-term or short-
term), giving rise to a benefit equal to the amount of taxes avoided as 
a result. In addition, one essential simplifying assumption has been 
made: we recommend that shares acquired through reinvestment be treated 
as having the same holding period as the initial investment, so that 
gain or loss on shares reinvested in the last year could be treated as 
long-term rather than short-term. This greatly simplifies the 
recordkeeping required to calculate post-liquidation return, with only 
a minor impact on the result.
    As you requested, our sample calculations do not include any 
provisions regarding whether the calculation methodology should be 
permissive (like a non-standard total return, which may be calculated 
many different ways) or mandatory (like a money market fund yield, 
which may only be calculated according to SEC guidelines). Nor do they 
address whether funds would be required to disclose after-tax returns 
in a specific document or permitted to disclose them according to a 
standard formula if desired. We note, however, that standardization is 
especially problematic where taxes are concerned, because investors are 
subject to such widely divergent tax regimes. And although the after-
tax calculations we describe have worked well as voluntary disclosure 
for our tax-managed products in the past, we have never published 
after-tax returns for our other funds and do not have experience as to 
how other investors would react to them.
    We appreciate the opportunity to assist the Division by describing 
our approach to after-tax returns, and look forward to additional 
discussions as your proposals progress. If you have any questions, 
please contact the undersigned at 617-563-6292 or Deborah Pege at 617-
563-6379.
            Sincerely yours,
                                                     David B. Jones
cc: Craig S. Tyle, Investment Company Institute
   Heidi Stam, The Vanguard Group

enclosure
      Methodology for Calculation of Mutual Fund After-Tax Returns
      fidelity management & research company draft--august 4, 1999
    A. General. After-tax returns should be calculated using the same 
assumptions and instructions as for average annual returns under Item 
21(b)(1) of Form N-1A, with the exceptions noted below.
    B. After-Tax Return (Before Redemption). For purposes of 
Instruction 2 to Item 21(b)(1), assume all taxable dividends or other 
distributions are reinvested after adjusting the distribution by an 
amount equal to the taxes applicable to the distribution. Do not assume 
complete redemption of shares as required by Instruction 4 to Item 
21(b)(1).
    C. After-Tax Return (After Redemption). Assume complete redemption 
as provided by Instruction 4 to Item 21(b)(1). In addition to the 
adjustments provided in Paragraph B above, adjust Ending Redeemable 
Value (ERV) by an amount equal to the capital gains taxes applicable to 
the redemption.
Instructions.
    1. Historical Tax Rates. Use the federal tax rates applicable to 
individual taxpayers as of the historical date of each distribution or 
redemption. In determining the historical tax bracket applicable to 
each taxable transaction, assume the investor had a constant level of 
income (adjusted for inflation) over the period.
    2. Distributions. Adjust each distribution before reinvestment by 
multiplying the amount of the distribution taxable at a given rate by 
one minus that rate. For example, adjust a distribution taxable as 
long-term capital gains by multiplying it by one minus the applicable 
tax rate for long-term capital gains.
    a. The taxable amount and tax character of each distribution should 
        be as specified by the fund on the dividend declaration date, 
        but may be adjusted to reflect subsequent recharacterizations 
        of distributions.
    b. In general, distributions should be adjusted to reflect the 
        federal tax impact on an individual taxpayer. Distributions 
        that would not be federally taxable to an individual (e.g., 
        those taxable as tax-exempt interest or as returns of capital) 
        should not be reduced before reinvestment.
    3. Redemption. Adjust redemption proceeds by multiplying the 
capital gain or loss upon redemption by the applicable tax rate and 
subtracting the result from ERV.
a. Calculate capital gain or loss upon redemption by subtracting the 
        total tax basis of the hypothetical $1,000 payment from the 
        redemption proceeds (after deduction of any non-recurring 
        charges as specified by Instruction 4 to Item 21(b)). State a 
        capital gain as a positive number and a capital loss as a 
        negative number, so that ERV will be adjusted downward in case 
        of a capital gain and upward in case of a capital loss.
b. In calculating the total tax basis of the hypothetical $1,000 
        payment, include the cost basis attributable to reinvested 
        distributions and any other costs basis adjustments that would 
        apply to an individual investor.
c. When determining the character of capital gain or loss upon 
        redemption, the fund may assume that shares acquired through 
        reinvestment of distributions have the same holding period as 
        the initial $1,000 investment.

    Mr. Gillmor. Thank you very much, Mr. Jones.
    Mr. Fink.

                  STATEMENT OF MATTHEW P. FINK

    Mr. Fink. Thank you very much, Mr. Chairman. I am pleased 
to say that the Investment Company Institute, the trade 
association for the mutual fund industry, strongly supports the 
bill's objective of improving disclosure to shareholders about 
the effect of taxes on mutual fund performance. As a witness on 
the previous panel on charitable contributions stated, 
disclosure has proved to be the best police officer in a lot of 
areas, and it certainly will be in this one. Mutual fund 
shareholders who have taxable accounts need to understand the 
important impact that taxes can have on their returns.
    We have been discussing the relevant issues with both the 
bill's sponsors on this subcommittee and with the Securities 
and Exchange Commission. I have to say some of the issues are 
much more complex than it first appears on the surface, but I 
am hopeful that the SEC will come out with a proposal in the 
near future. We look forward to working with the SEC to resolve 
swiftly these various issues, and to get a final rule in place, 
as the prior witnesses said, to set an industry standard. Once 
there is a final rule, we hope that rule will meet the needs of 
investors, meet the expectations of the sponsors on this 
subcommittee, and I think it will enjoy the very strong support 
of the fund industry.
    To name some of the issues that have to be resolved as a 
threshold matter, the SEC will have to decide whether it is 
best to expand upon existing disclosure requirements in 
prospectuses and annual reports, or to require funds to 
calculate one or more after-tax numbers as the other two 
witnesses have suggested.
    If in fact an after-tax number is used, perhaps in a series 
of difficult computational issues, the most significant one is 
the one that the two witnesses before me highlighted: whether 
the return should simply be based on a preliquidation basis, 
which assumes that the investor receives dividends and capital 
gain distributions but holds his or her shares after the end of 
the period, or instead on a postliquidation basis, which 
assumes again that the investor receives distributions, but 
also that he or she redeems his or her shares at the end of the 
period.
    As you just heard, there are different views in the 
industry, and this will be probably one of the most important 
issues the SEC will have to hammer out. There are other issues. 
Just to give you the obvious one that Mr. Jones just mentioned, 
which tax rate do we assume?
    Both Vanguard and Fidelity have been urging using the 
highest taxable rate, which I think is 39.6 percent, but that 
applies only to a very small number of fund shareholders. Most 
are in far lower tax brackets, so you have an issue of which 
tax bracket to use.
    But if I had to conclude with one final point, I want to 
emphasize how important it is going to be if an after-tax 
number or numbers are used. There has to be very careful 
textual disclosure of the inherent limitations in the numbers 
and of how one should look at them. Otherwise we could all 
easily inadvertently mislead investors.
    Let me give three possible areas that we have to worry 
about. First, investors have to be told that after-tax returns 
will vary from investor to investor depending on their Federal 
tax rate and their State situation. And of course we have to 
make clear to the 50 percent of shareholders who are in tax-
exempt accounts, IRAs, 401(k) plans, that none of this makes 
any difference to them.
    Second, we have to again tell investors that while taxes 
are very important, as indicated by Mr. Gillmor's chart, taxes 
are only one important factor to consider. It is not the only 
factor.
    And third, if I had to stress one point, and as Mr. Markey 
stated in his opening statement, it has to be made very clear 
to investors that these numbers are in no way predictive of 
what is going to happen in the future. You could very easily 
have a fund which has been very tax efficient in the past, and 
in the new year ahead of us it could have substantial taxable 
distributions, in part because the size, scale, and timing of 
the distributions often are out of the control of the portfolio 
manager of the fund. So we really have to warn investors that 
this is not predictive.
    I am confident, based on working with people like those on 
this panel and with the SEC over the last 28 years, that all of 
this can be resolved in SEC rulemaking.
    I would like to thank the chairman and the other members of 
the committee for their leadership in this area, and we are 
hopeful and confident that it will all soon be resolved. Thank 
you.
    [The prepared statement of Matthew P. Fink follows:]
 Prepared Statement of Matthew P. Fink, President, Investment Company 
                               Institute
                            i. introduction
    My name is Matthew P. Fink. I am the President of the Investment 
Company Institute, the national association of the American investment 
company industry.1
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    \1\ The Investment Company Institute is the national association of 
the American investment company industry. Its membership includes 7,729 
open-end investment companies (``mutual funds''), 485 closed-end 
investment companies and 8 sponsors of unit investment trusts. Its 
mutual fund members have assets of about $6.010 trillion, accounting 
for approximately 95% of total industry assets, and over 78.7 million 
individual shareholders.
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    I appreciate the opportunity to testify today on H.R. 1089, the 
``Mutual Fund Tax Awareness Act of 1999.'' This bill, introduced by 
Representatives Gillmor, Markey and nine co-sponsors, would direct the 
Securities and Exchange Commission (``SEC'') to develop a rule to 
require mutual funds to disclose the effects of taxes on returns to 
fund investors.
    The Institute thanks you for giving us the opportunity to work with 
you on this legislation. Ensuring that mutual fund investors understand 
the impact that taxes can have on returns generated in their taxable 
accounts is entirely consistent with the Institute's long-standing, 
strong support for initiatives to improve disclosure to investors.
    The industry has taken several steps to promote the disclosure 
improvements sought by the legislation. Following the introduction last 
year of similar legislation, the Institute formed a task force of its 
members to develop approaches for identifying and resolving the complex 
issues associated with disclosing after-tax returns. The industry has 
had discussions with Mr. Gillmor, Mr. Markey, others of you, and the 
SEC regarding after-tax return disclosure issues. We submitted 
materials to the SEC in July regarding possible methodologies for 
calculating after-tax returns.
    We understand that the SEC staff is actively considering this 
matter. The Institute is committed to working with the Congress and the 
SEC as this process moves forward toward completion.
    The remainder of my testimony provides background on the tax 
aspects of investing in mutual funds, a summary of current disclosure 
requirements and finally a discussion of approaches to after-tax 
disclosure and issues raised by these approaches.
                ii. tax aspects of mutual fund investing
    A mutual fund shareholder invested in a taxable account may be 
taxed on his investment in two ways: first, when the fund distributes 
its income and net realized gains (whether received in cash or 
reinvested in additional shares); second, when the investor redeems 
fund shares at a gain (whether received in cash or exchanged for shares 
in another fund).
A. Distributions to Shareholders
    The timing and character of mutual fund distributions is governed 
by the Internal Revenue Code. The Code effectively requires a mutual 
fund to distribute all of the income and net gains from its portfolio 
investments annually. A fund's distributions may be taxable to the 
shareholder in two different ways: (1) as ordinary income (e.g., 
dividends, taxable interest and net short-term capital gains) or (2) as 
long-term capital gains (i.e., capital gain dividends attributable to 
net long-term capital gains). This is the case whether the shareholder 
takes his distributions or reinvests them. Distributions also may be 
exempt from tax (e.g., exempt-interest dividends attributable to tax-
exempt interest).
    The amount of mutual fund distributions can be affected by a fund's 
investment policies and strategies (e.g., depending on whether it has a 
policy of actively trading its portfolio) and by factors outside the 
control of the fund's investment adviser. For example, a fund that 
experiences net redemptions can be forced to sell portfolio securities 
to meet redemptions and thereby realize gains that it otherwise would 
not.
B. Redemptions by Shareholders
    Redemptions (sales) of mutual fund shares result in taxable gain 
(or loss) to the redeeming investor (whether the proceeds are received 
in cash or exchanged for shares of another fund). This gain or loss is 
based upon the difference between what the investor paid for the shares 
(including the value of shares purchased with reinvested dividends) and 
the price at which he sold them.
    All of a fund investor's economic return ultimately is received 
either as a distribution or as redemption gain. Consequently, there is 
a clear inverse relationship between these two tax consequences. If a 
fund makes relatively lower distributions because it does not realize 
its gains, gains build up in the fund. Consequently, a redeeming 
shareholder will have larger capital gains upon redemption than he 
otherwise would have had if the fund had realized and distributed the 
gains.2
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    \2\ For example, consider two funds (A & B) each of which has a 
$10.00 net asset value (``NAV'') at the beginning of the measurement 
period and an $11.00 NAV at the end of the period (before 
distributions). The $1 increase in NAV represents a 10% return for the 
measurement period. Further assume that Fund A distributes $0.20 per 
share and Fund B distributes $0.40 per share on the last day of the 
measurement period. An investor in Fund A receives 20% of the return in 
the form of a $0.20 per-share taxable distribution, with the remaining 
80% of the return presently untaxed in the form of an $0.80 increase 
from the original $10.00 NAV. An investor in Fund B, in contrast, 
receives 40% of the return in the form of a $0.40 per-share taxable 
distribution, with the remaining 60% of the return presently untaxed in 
the form of a $0.60 increase from the original $10.00 NAV.
---------------------------------------------------------------------------
C. Nontaxable Accounts
    It is important to note that the tax impact discussed above is not 
applicable in the case of investors that hold their mutual fund shares 
in a tax-deferred account, such as a qualified employer-sponsored 
retirement plan (e.g., a 401(k) plan), or an Individual Retirement 
Account. As of year-end 1998, 45% of all mutual fund assets (other than 
money market funds), and 50% of all equity fund assets, were held in a 
tax-deferred account.3
---------------------------------------------------------------------------
    \3\ Source: ICI data used in publishing 1999 Mutual Fund Fact Book 
(39th ed.).
---------------------------------------------------------------------------
                  iii. current disclosure requirements
    The SEC currently requires that the general tax effect of investing 
in mutual funds be disclosed to investors in a plain English narrative 
in a fund's prospectus. Mutual funds are required to describe ``the tax 
consequences to shareholders of buying, holding, exchanging and selling 
the Fund's shares,'' including, as applicable, specific disclosures 
that distributions from the fund may be taxed as ordinary income or 
capital gains, that distributions may be subject to tax whether they 
are received in cash or reinvested, and that exchanges for shares of 
another fund will be treated as a sale of the fund's shares and subject 
to tax.4 Any fund that may engage in active and frequent 
trading of portfolio securities also is required to explain the tax 
consequences of increased portfolio turnover, and how this may affect 
the fund's performance.5
---------------------------------------------------------------------------
    \4\ See Item 7(e) of Form N-1A. There are also special disclosures 
required of tax-exempt funds.
    \5\ See Instruction 7 to Item 4(b)(1) of Form N-1A.
---------------------------------------------------------------------------
    All funds are required to provide investors with other information 
that may reflect the tax consequences of investing, including the 
fund's portfolio turnover rate and the amount of its net unrealized 
gains.6 The financial highlights table, which is required to 
be included in fund prospectuses and annual reports, also contains 
information on a fund's distributions, including distributions 
attributable to income and to realized gains.7
---------------------------------------------------------------------------
    \6\ Portfolio turnover rate is included in the fund's financial 
highlights table (see Item 9(a) of Form N-1A); net unrealized gains are 
reported in the fund's financial statements (see Rule 6-05 of 
Regulation S-X).
    As was noted recently in Morningstar FundInvestor, however, a 
fund's portfolio turnover and potential capital gains exposure are at 
best only loosely correlated with the level of a fund's taxable 
distributions. See Morningstar FundInvestor, Vol. 8 No. 1, September 
1999.
    \7\ See Item 9(a) of Form N-1A.
---------------------------------------------------------------------------
                    iv. issues for sec consideration
    The Institute agrees with the intent of H.R. 1089 and supports the 
approach taken under H.R. 1089, which leaves after-tax disclosure to 
SEC rulemaking. Development of this disclosure will require the 
consideration of several surprisingly complex issues, some of which may 
not be immediately apparent. Thus, this issue is a good candidate for 
the rulemaking notice and comment process, where especially complex 
issues can be resolved.
A. Improved Narrative Disclosure vs. Providing One or More After-Tax 
        Return Numbers
    A threshold matter that the SEC will have to consider is whether to 
expand upon the existing required disclosures, or to require funds to 
calculate one or more after-tax return numbers. On the one hand, an 
after-tax number might appear more straightforward, as it would not 
require a shareholder to review financial statements and apply the 
correct tax rates in order to determine the effects of taxes upon his 
return. In this way, it also might facilitate the ability of 
shareholders to compare different funds.
    On the other hand, an after-tax number could have inherent 
limitations. As described more fully below, in order to compute an 
after-tax number, funds will have to make a series of assumptions, many 
of which may not be applicable to any particular shareholder. This runs 
the risk of inadvertently misleading investors. It also should be noted 
that other financial products, including ones that compete with mutual 
funds, are not required to disclose their after-tax returns and thus 
comparisons between competing products will not be 
possible.8
---------------------------------------------------------------------------
    \8\ The SEC may decide to require some funds, but not all, to 
disclose their after-tax returns. The SEC could either exempt some 
funds, such as money market funds or funds sold principally to tax-
deferred accounts, or only apply the requirement to certain types of 
funds, such as funds that hold themselves out as ``tax managed''.
---------------------------------------------------------------------------
    Assuming the SEC determines that it is appropriate to require funds 
to disclose an after-tax return number, two types of issues will have 
to be addressed. The first relates to the actual computation of after-
tax return(s). The second relates to the need to ensure investor 
understanding of this information.
                    B. Computational Considerations
    1. After-Tax Calculations on a Pre-Liquidation and/or Post-
Liquidation Basis--Perhaps the most significant computation issue is 
whether any after-tax return formula should assume that the investor 
continues to hold, or instead redeems, his shares at the end of the 
period for which the return is being calculated. If the formula assumes 
that he holds the shares (the ``pre-liquidation calculation''), the 
after-tax return would be calculated by reducing the fund's total 
return by the tax due on distributions made during the measurement 
period. If the formula assumes that he redeems the shares (the ``post-
liquidation calculation''), the return would be further adjusted to 
reflect capital gains (or possibly capital losses) that would be 
realized upon redemption.
    The first (pre-liquidation) alternative is intended to disclose the 
tax effects only of actions taken by the fund, by reflecting the tax 
impact of distributions made by the fund during the measurement 
period(s). The second (post-liquidation) alternative, in contrast, also 
reflects the potential impact of taxes on (1) unrealized appreciation 
in the fund's portfolio and (2) realized but undistributed capital 
gains. It thus better discloses an investor's total potential tax 
exposure but, in order to do so, assumes that the investor will redeem 
his shares at the end of the measurement period, which will probably 
not be the case.
    2. Federal and State Tax Rate Assumptions--Other significant issues 
involve the assumptions regarding applicable federal and state income 
tax rates to be used (or not used) in calculating after-tax returns. 
For example, which federal tax rate should be applied to income 
distributions? As a preliminary matter, the Institute believes that it 
may not be appropriate to apply the top federal tax rate (currently 
39.6%) to fund distributions, since this rate currently applies to 
individuals with a taxable income of more than $283,150, while the 
median income of mutual fund shareholders is approximately 
$55,000.9 Another issue is whether current or historical 
rates should be used. For example, if a fund were computing its 10-year 
after-tax return, should it apply the 1990 income tax rates to 
distributions made in 1990, or the present day rates? Finally, the SEC 
will have to consider whether other taxes, such as state tax, should be 
reflected; because of the complexity, the Institute believes that they 
should not.10
---------------------------------------------------------------------------
    \9\ Source: ICI 1999 Mutual Fund Fact Book (39th ed.) 45.
    \10\ Other computational issues are noted in the attached Institute 
letter to the SEC.
---------------------------------------------------------------------------
C. Ensuring Investor Understanding of the Information
    The after-tax return numbers must be accompanied by disclosure that 
informs investors of their appropriate use and inherent limitations. 
Otherwise, investors could misunderstand them, and be inadvertently 
misled as to the impact of taxes on their returns.
    1. After-Tax Returns Vary From Investor to Investor--It must be 
clearly disclosed to fund investors that after-tax returns will vary 
significantly from investor to investor (unlike pre-tax total returns, 
which are equally relevant for all investors in a fund for the 
measurement period).11 Thus, any after-tax return disclosed 
by a fund may not, and probably will not, reflect a fund shareholder's 
own individual circumstances. There are as many after-tax returns for a 
given pre-tax return as there are possible combinations of potentially 
applicable federal and state tax rates. In addition, different 
investors in the same fund may be more or less tax-sensitive depending, 
for example, on an investor's ability to offset distributed capital 
gains against unrelated, realized losses. And, for some investors--such 
as those who hold fund shares in IRAs or 401(k) plans--after-tax 
returns will have no relevance.
---------------------------------------------------------------------------
    \11\ Under the SEC's methodology for calculating pre-tax total 
return, which assumes a hypothetical $1,000 investment and the 
reinvestment of all fund distributions, all investors in the fund 
throughout the measurement period will have the same return (provided 
they have the same account transactions--e.g., all dividends are 
reinvested, no other share purchases occur and no shares are redeemed).
---------------------------------------------------------------------------
    2. After-Tax Return Numbers Are Not Predictive--There are 
``predictive'' limitations to an after-tax return number. As noted 
above, the future behavior of some fund shareholders (e.g., redemption 
activity) can have a significant impact on other shareholders' after-
tax returns. In addition, ``good'' past after-tax returns could mean 
that the shareholder has more potential tax exposure in the future. If 
most of a fund's gains were unrealized, those gains could lead to 
greater distributions in the coming years.
    Thus, the Institute would recommend inclusion of a cautionary 
legend, similar to that required for total pre-tax return data, 
disclosing that an after-tax return number reflects past tax effects 
and is not predictive of future tax effects.
    3. Taxes Are One of Many Important Factors When Making Investment 
Decisions--While taxes are an important consideration for investors 
purchasing fund shares in their taxable accounts, other factors also 
are important. For example, investors purchase bond funds to receive 
current distributions of interest income, taxable at federal tax rates 
up to 39.6% (except in the case of municipal bond funds). A taxable 
investor's goal should be, consistent with his investment objectives, 
to maximize after-tax returns rather than to minimize taxes.
                             v. conclusion
    The Institute appreciates the opportunity to testify before the 
Subcommittee. We support the objectives of the ``Mutual Fund Tax 
Awareness Act of 1999'' to improve disclosure to investors of tax 
effects on mutual fund total returns. We will continue to work with the 
Congress and the SEC in order to achieve a result that will be most 
useful for our 77 million shareholders.

    Mr. Gillmor. Thank you very much, Mr. Fink.
    I might say that I agree that it isn't as simple as it 
might first appear. You have the pre- and postredemption 
problem, and you have the problem that it is not going to treat 
all taxpayers the same, but it is a guide and information that 
they don't have now. In that sense I think we at least would 
have less confusion.
    But let me ask you, Mr. Fink, or any other members of the 
panel, do you have any idea at this point how many of those 
thousands of mutual funds out there do some kind of after-tax 
disclosure?
    Mr. Fink. I believe there are now 30 tax-managed funds that 
do that, and I think there are something like 200 index funds 
which probably also talk about the area.
    Mr. Dickson. In terms of actually disclosing an after-tax 
return, to my knowledge some tax-managed funds do it, the 
numbers that Mr. Fink cited. And to this point, Vanguard just 
recently announced that we will be doing it for 47 of our 
funds, and also providing the information. Although not in 
shareholder reports, for most of the remainder of our funds 
through Web site or over the phone.
    Other than that, I am not aware of any widespread after-tax 
disclosure of returns within the industry.
    Mr. Gillmor. All of that is a very small percentage. I 
would guess that it is probably a significant improvement over 
5 years ago, when I doubt if anybody did it.
    Let me ask, Mr. Jones, Fidelity's after-tax returns of 
Fidelity's tax-managed fund, what is your evaluation of how 
shareholders have received and reviewed that information and 
have you given any thought of publishing those kind of returns 
on other equity funds?
    Mr. Jones. The tax-managed fund shareholders that we have 
communicated this sort of return to have, I think, found it 
useful generally. I think I take it as a favorable reaction 
that we haven't had too many questions. One of our concerns 
early on was will people just say, ``What the heck does this 
number mean?'' But it seems it has been effective in 
communicating to the investors in that category who are 
interested in tax impact before they invest in the fund at all.
    For our other funds we don't presently calculate the 
number. Like most fund groups, we have a lot of information on 
tax impact available but most of it is narrative or it is 
information like how much distributions have been paid. It 
isn't pulled together to a return number. Looking at the 
future, I think regardless almost of action by the Securities 
and Exchange Commission, I think customer demand will require 
us to make that information available on more funds.
    Mr. Gillmor. It would seem to me because of the different 
ways this can be disclosed, one of the advantages of the 
legislation is that we get a uniform disclosure so that 
shareholders can really be comparing apples and apples. I will 
yield back.
    Mr. Markey?
    Mr. Markey. Thank you, Mr. Chairman, very much. This is a 
very interesting chart that is up in the room today. The 
numbers we have before them, that would probably surprise a lot 
of investors to see the huge differential that exists between 
what they might see in the newspaper and then what ultimately 
winds up going to them and the role which taxes plays in 
reducing that total.
    I think what Mr. Gillmor and I have as our intent is just 
that the investor can see this, understand it, and then make 
marketplace judgments. And the logical differential, of course, 
is the greater the likelihood that an investor will move over 
to another fund.
    My entire investment is relatively modest in a Fidelity 
Spartan Index 500 Fund, and while the fees are slightly higher, 
almost infinitesimally higher than Vanguard, Fidelity is in 
Boston so I stick with Fidelity. They are the hometown team. 
But if combined with the tax management, combined with other 
things, the number just kept getting larger and larger, then I 
think there would be some reason to reconsider and it is just, 
I think, a matter of information that will ultimately determine 
the extent to which people are loyal for secondary 
considerations and how much the primary considerations are just 
overwhelming.
    And that is what I think we are trying to achieve here. So 
for all of you, I understand that the average portfolio 
turnover rate for an actively managed non-index mutual fund has 
increased from 30 percent 20 years ago to 90 percent today, 
managers who turn over their portfolios without considering the 
tax consequences of their decisions on fund investors might 
sell stocks in which the fund has made short-term gains, and 
other long-term gains without offsets, resulting in higher 
yearly taxes for investors.
    Again, you do agree, according to your testimony, that the 
investors should get the right to the disclosure of the tax-
adjusted performance for that fund. Do you agree with that? 
Both of you?
    Mr. Dickson. That's correct.
    Mr. Jones. Yes.
    Mr. Markey. Mr. Fink, you indicated that one of the key 
issues for the FCC to make is a decision in the rulemaking 
mandated by the Gillmor-Markey bill which would be to determine 
what type of after-tax number should be disclosed. The two 
options you mention are, No. 1, a preliquidation after-tax 
return and two, a postliquidation after-tax return. Does the 
ICI have a position at this time as to which of these two 
options is preferable?
    Mr. Fink. No, particularly because I have my two biggest 
members sitting next to me who disagree on this. It has been 
talked about with other members but I think it really shows why 
you need--not to dodge the question--you really need an SEC 
public hearing to hear not only from people in the industry but 
the consumer groups, the Consumer Federation, the Association 
of Individual Investors. There are very good arguments for 
both. And I think you really need a public hearing and an open 
dialog, and I personally do not have a view at this point.
    Mr. Markey. Thank you, Mr. Fink, for setting up the 
discussion. I appreciate it. So, Mr. Dickson, your firm, 
Vanguard, has recently begun disclosing after-tax returns. And 
I see from your testimony that you favor disclosure of 
preliquidation returns. Can you tell us why and why it is 
preferable to postliquidation?
    Mr. Dickson. Sure. There are a number of considerations. 
First of all let me say, and I certainly think I share this 
view with Mr. Jones, that we see value in both numbers. It is a 
question of presentation and a question of what is in the best 
interest to convey the information that we are trying to make. 
In the case of Vanguard and our decision to make preliquidation 
returns available through shareholder reports, we feel that the 
shareholder report talks about the actions of the portfolio 
manager that affect all shareholders in the fund. That is, the 
distributions of dividends and capital gains that are given to 
all shareholders in the fund. That is a preliquidation 
calculation.
    It is certainly the case, and we have disclosure to this 
effect in our presentation, that additional taxes may be owed 
if you sell the fund's shares. However, just from one sort of 
level, annual reports only go to shareholders that are 
currently in the funds, so if you sell your fund's shares, you 
are not getting an annual report. Second, we do feel this is 
important information, but we feel it doesn't rise to the level 
of disclosure in the annual report. Instead, we would plan to 
make it available through other vehicles that are customized 
ways of showing an individual shareholder return, like through 
the Web or over the phone, where people can input, especially 
over the Web, different tax rates, different tax treatments, to 
be able to calculate their specific tax-adjusted return. For 
that level. To keep the clarity brief and to not overwhelm 
shareholders with a whole slew of different numbers for 
different time periods and different methodologies, we chose 
the preliquidation return as the best approach.
    Mr. Markey. Mr. Jones, Fidelity favors postliquidation 
returns. Could you explain from your perspective the case for 
that kind of disclosure as opposed to the Vanguard 
preliquidation approach?
    Mr. Jones. Absolutely. Just to clarify, our preference of 
what we have done in calculating and presenting these figures 
in the past has not been to show postliquidation only. It has 
been to show preliquidation and postliquidation. So the 
differences between Vanguard's approach and ours are actually 
perhaps smaller than they might appear. It is truly best seen 
as the difference between showing a preliquidation return and 
putting in the footnote, ``postliquidation returns may be 
lower,'' which is more or less the Vanguard approach, noting 
that there may be other taxes due. Or, what we feel is 
necessary, saying preliquidation return is X, the 
postliquidation return is Y, and actually giving the actual 
amount of the difference.
    Now, I think we felt that that is necessary in part to make 
sure that all taxes are taken into account so that you have a 
truly after-tax number and to make sure that any exit fees or 
other charges are taken into account as currently required by 
other SEC regulations.
    Mr. Markey. But in your testimony, just so I can focus in 
on this pre- and post- issue, whichever one is going to lead, 
in other words, and then have the footnote after the lead 
number--what Mr. Dickson is saying in his testimony is that 
disclosing postliquidation tax-adjusted returns hinges the 
disclosure to the investor's decision to sell the fund rather 
than the fund manager's skill of performance in taking account 
of the tax consequences of the manager's buy or sell decisions. 
What is your response to that argument?
    Mr. Jones. I would say it is true that the preliquidation 
and postliquidation returns are both based on a hypothetical 
investor. Both of them are hypothetical numbers saying let's 
assume that $1,000 is put into a fund at a given time, whether 
it is pre- or after-tax, in fact. The charges applicable to an 
account of that size are taken into account and then in the 
case of a preliquidation return, there is an assumption that 
the investor hasn't sold any shares and so there is an embedded 
tax liability that is unpaid. In postliquidation, there is an 
assumption that the investor did liquidate his or her shares. 
We feel that is a perfectly reasonable assumption, especially 
given the fact that standardized returns are required for 
periods up to 10 years. A tax-sensitive investor isn't really 
likely to trade out of their fund in 1 year if they are at a 
gain because they are a tax-sensitive investor and they would 
probably be reluctant to take a short-term gain. But quite a 
few investors in mutual funds, although we would like them to 
stay with us indefinitely, would have sold some of their shares 
by the time 10 years is up.
    Mr. Markey. And, Mr. Dickson, Mr. Jones' testimony suggests 
that failing to disclose postliquidation returns gives a false 
picture of the impact of taxes on mutual fund investors because 
they foster the impression that taxes can be deferred 
indefinitely, when in fact they can't. How do you respond to 
that?
    Mr. Dickson. I completely agree with that approach. It is a 
question of whether--and, in fact, we address that in our 
disclosure by saying that in fact you may very well owe 
additional taxes at the time that you sell your fund shares. We 
just don't want to deem that redemption on the shareholder, 
which is a shareholder-specific action as opposed to a 
portfolio management action, and that deeming of redemption may 
or may not have actually occurred by the shareholder.
    Certainly there is some unrealized potential tax liability, 
but to a certain extent you could even construct situations 
where you do get out of that tax liability the postliquidation 
scenario if the mutual fund shares passed through an estate or 
are given away as a charitable contribution. So it is really 
focusing on what the manager is effecting in terms of the 
performance for all shareholders in the fund as opposed to any 
particular shareholder.
    Mr. Markey. Thank you, Mr. Dickson. I thank you, Mr. 
Chairman, for the extra time. Thank you.
    Mr. Gillmor. Before I go to Mr. Cox, I just thought of an 
advantage for this bill that I hadn't before and I don't know 
if Mr. Markey will agree with this result, but the more that 
people know--there are half the families in the country that 
own stock--how much their taxes are, we might get a lot more 
support for tax cuts here.
    Mr. Cox.
    Mr. Cox. That is very true.
    Mr. Dickson, you mentioned something a moment ago that I 
think this whole discussion is pregnant with, and the Web, and 
what your firm might do with it. I wonder if I could ask you 
what you consider the SEC might do with it, specifically? 
Should we imagine a future in which you all provide 
standardized inputs to the SEC, they put a calculator up on the 
Web as a potential investor and answer a few simple questions 
on the SEC's Web site, such as whether I have got any 
offsetting capital losses myself, what my tax bracket is and 
what State I live in, and let it rip?
    Mr. Dickson. Certainly that is possible. We view it--and 
certainly the SEC has actually done quite a nice service with 
putting up a cost comparison calculator on their Web site. 
However, at the end of the day, Vanguard wants to serve 
Vanguard shareholders, and to the extent there is a 
standardized calculation which this bill would address, then we 
can get those same results from doing individualized work on 
our own Web site as opposed to sending everything to the SEC.
    Mr. Cox. So the advantage would be simply that we would 
have the same measures, the same calculator across the industry 
rather than boutique calculator here and there and all slightly 
different?
    Mr. Dickson. Well, the one thing that I would say is there 
is certainly a lot more information that you might be able to 
pull of shareholders than just some specific items that you 
would send, as you were saying. You might be able to customize 
it based on information that only--that Vanguard might have for 
its shareholders or that the shareholder might have when 
logging on. We would just view--in terms of the presentation 
ourselves, we would love to do it and in fact we are planning 
to do it, to provide customized after-tax return calculations 
for shareholders on our Web site.
    Mr. Cox. I am not sure whether you think it would be 
appropriate for the SEC to do this.
    Mr. Dickson. I would say we would prefer to do it 
ourselves.
    Mr. Cox. Do our other witnesses have a view?
    Mr. Jones. I think there are commercial services at present 
that are in the business of providing hypothetical performance 
information on a pretax basis. The data collection involved is 
actually fairly significant as is the data maintenance. It 
would be a new role for the SEC to move into that business and 
say that they will provide hypothetical return calculations. I 
think it is a question for gentlemen like yourselves as to 
whether that is an appropriate role. I would expect the same 
sort of third-party hypothetical performance providers would 
adopt an after-tax calculation, as they have in the past with 
other standard return calculations, once they have been 
standardized by the SEC.
    Mr. Cox. Having heard what your members think, Mr. Fink, 
what do you think?
    Mr. Fink. I would guess that they wouldn't see anything 
wrong with the SEC doing it, but I think they would say better 
to have the marketplace do it; and given all the SEC's other 
responsibilities, they probably would say have individual firms 
do it. That is why I think the industry would come out.
    Mr. Cox, I have an add-on which may sound disconnective but 
I want to make the point we are talking to two fund groups that 
sell directly to consumers basically. That is almost their 
entire business. That is a minority. Eighty percent of fund 
investors buy through third parties. Now, some of them may use 
the Web, but their biggest inclination is probably go to their 
broker, financial planner, bank, or employer because they are 
buying through third parties. It just changes when you look at 
the industry where people get information from. Their 
shareholders would go to them. If you are investing in the 
other 80 percent, you probably would not go to the web site of 
your fund. You would go----
    Mr. Cox. If I am buying through a broker, my broker could 
do it.
    Mr. Fink. I'm sorry?
    Mr. Cox. I am sorry, too. I am a little hoarse today. If I 
am buying through a broker, my broker could use the SEC site?
    Mr. Fink. Yes.
    Mr. Cox. It amounts to the same thing?
    Mr. Fink. Yes.
    Mr. Cox. I have to say I'm a little bit surprised to hear a 
discussion about whether we should be doing pre- or 
postliquidation returns. Why in the world would we do both? 
Mutual funds are supposed to be liquid assets and therefore the 
idea of liquidating them shouldn't come as a shock. It is the 
very purpose that one would put funds there as opposed to 
something less liquid, and I think you ought to be able to get 
both answers.
    In this era of cheap computing, it is not a great deal of 
trouble. It is amazingly routinized. Once you have got the 
information, the computer can crank out that data all day long 
and customize it for every individual investor at essentially 
zero cost. I think the greater concern here is all the 
assumptions that have to be made that haven't anything to do 
with the complexities of tax law but, rather, there is a built-
in major league assumption up front that the past is prologue, 
as Shakespeare would put it, that these are in any way 
predictive measures.
    And yet because we haven't anything else to go by, I think 
we all sort of swallow hard and look at what happened in the 
past and make our best guess about the future. We are also 
assuming that the taxpayer's current situation, which is all 
the taxpayer knows, is going to be the taxpayer's situation in 
the future. So you have got a double probabilistic variable 
here, that you not only need to concern yourself with whether 
the fund is going to be the same as the fund was in the past, 
but whether you and your tax situation are the same in the 
future. Then you have got us to worry about up here. Is 
Congress going to keep the same tax laws in place in the future 
that we have had in the past, and we haven't had any discussion 
whatsoever about States, but of course that is another layer of 
uncertainty. And in all of these sorts of things are what the 
market can do.
    That is why we despair, ourselves, of trying to provide 
direction or guidance to investors on these funds and rather 
say, ``Here is the information, you do with it what you will.'' 
What we are talking about here today is simply getting them the 
basic information that they can then evaluate and put in the 
Cuisinart with all these variables and uncertainties. I would 
hope we would strive to put as much hard data that we know is 
available in front of people rather than keep that back, 
because even once you have all the hard data, you are still out 
there in the middle of guess land. Otherwise, we would all be 
wealthy.
    Mr. Gillmor. Thank you very much, Mr. Cox. I want to thank 
the members of our panel and also the previous panel.
    Mr. Markey. Mr. Chairman?
    Mr. Gillmor. Yes, Mr. Markey.
    Mr. Markey. I thank you very much. First of all, I would 
like to follow up on Mr. Cox's line of questioning which I 
think focuses on the issue of whether or not the compromise 
between the two positions might not be disclosure of both, 
which is I think very much an interesting--again, something we 
can't determine, but I think that is an interesting approach 
that has to be considered, given the technological capacity of 
the SEC or any of these firms.
    And I would also like to endorse the proposal by the 
gentleman from California that the SEC's Web site put data up 
mainly because, to be honest with you, that Web site would be 
subject to the Privacy Act which governs the retransfer of any 
of the information, and as a result people are going to be 
putting all of their financial data into a formula which would 
be on-line and in the hands of some private-sector company that 
would not be secure under our laws. Even the financial services 
modernization bill we are passing right now provides no privacy 
protection if the information is in the hands of the financial 
institution. So if we were going to do it and the individual 
wanted to use this type of a service but didn't want to 
disclose their entire tax position to Vanguard or Fidelity, 
using the SEC under the Privacy Act would probably be a good 
alternative.
    Mr. Cox. If the gentleman would yield, I think it is very 
important. People do feel a little bit more comfortable with 
the SEC than they do with some firms, not all of them, Vanguard 
and Fidelity, that they have never met before. On the other 
hand, I note that there is a subset of the population that 
probably feels a lot more comfortable providing their actual 
tax information to a private firm than they would to the U.S. 
Government.
    Mr. Markey. I agree with that. The reality is that the SEC 
is probably the most respected agency in the Federal 
Government. They are in fact viewed as the cop on the beat, the 
guardian of the investor. The greatness of this industry, of 
course, is that they come to us with the most impeccable record 
of any part of the financial services community and that is to 
the credit of the mutual fund industry that they have been so 
willing to accept the kinds of regulations that we are even 
talking about today to ensure the investor is king.
    So hopefully, as a result of legislation, we will be able 
to move it forward quickly, pass it in the House, have some 
response for the Senate, so that perhaps by the end of next 
year investors across this country could have this kind of 
information available to them before they are making their end 
of year 2000 decisions as to how they want to handle their 
investment portfolio.
    I thank each of you for your excellent testimony. I yield 
back.
    Mr. Gillmor. Thank you very much. We stand adjourned.
    [Whereupon, at 11:27 a.m., the subcommittee was adjourned.]
    [Additional material submitted for the record follows:]
                   Association of Publicly Traded Companies
                                                   October 28, 1999
The Honorable Tom Bliley
Chairman, Committee on Commerce
2125 Rayburn House Office Building
Washington, DC 20515-6115

The Honorable Michael G. Oxley
Chairman, Subcommittee on Finance and Hazardous Materials
2125 Rayburn House Office Building
Washington, DC 20515-6115

RE: Hearing on H.R. 887, Charitable Contributions Disclosure

    Dear Chairman Bliley and Chairman Oxley: I am writing on behalf of 
the Board of Directors of the Association of Publicly Traded Companies 
to express our opposition to HR 887. While we have great respect for 
the sponsors of the legislation, we believe that new government 
regulation of this type will be counterproductive. I request that this 
letter be included in the record of the hearing.
                              introduction
    The Association of Publicly Traded Companies (``APTC'') represents 
a wide range of public companies from the newest and smallest to 
larger, more established firms. Many of the Association's member 
companies are in the high-growth sector of the nation's economy. Our 
members are from the every American industry, representing the breadth 
and diversity of the entire economy. Moreover, our members develop the 
products and services upon which America's long-term economic health 
depends. As SEC registered public companies, all of our members would 
be required to make the new disclosures that are contemplated in H.R. 
887. For all of these reasons, APTC believes that our comments deserve 
careful consideration.
          the association's position in opposition to h.r. 887
    Public companies are eager to communicate with investors on 
critical issues. In order to understand their investments, shareholders 
need the right kind of information about the company--audited financial 
statements, description of the business and the stated vision of the 
managers--in a clear concise document. APTC is concerned that too much 
of the information currently mandated by the SEC, especially in the 
proxy statement, distracts shareholders from the core questions of 
sound investing. H.R. 887 would add more distracting information to the 
proxy.
    Moreover, H.R. 887, if enacted, would continue a disturbing trend 
toward more and more mandatory disclosure of non-material information. 
Investors should receive information that is material to investment 
decisions. Once this ``materiality'' rule gives way to a ``for what 
it's worth'' rule, the scope of natural curiosity is the only limit.
There is no need for the new disclosures that H.R. 887 would mandate.
    We are mindful of Justice Louis Brandeis' famous admonition that 
``[s]unlight is said to be the best of disinfectant . . .'' However, it 
is not clear that corporate philanthropy needs disinfecting. We see no 
evidence of corporate charitable profligacy. Nor are corporate 
directors sacrificing their integrity and violating their fiduciary 
duties in exchange for contributions to their favorite charities.
Requiring charitable contribution disclosure in the proxy will be 
        counterproductive.
    Governmentally mandated disclosure about extraneous matters 
distracts investors from material information about the company. 
Specific information about charitable contribution will send a 
confusing and erroneous message, i.e., ``the SEC, your investor 
advocate, thinks that this information is important to you as an 
investor.'' The limited time that the investor has to study the 
potential long-term performance of the company may well be squandered 
pondering the significance of the company's charitable contributions.
    Unfortunately, the annual proxy materials are already replete with 
information of marginal significance to the long-term performance of 
the company. In fact, proxy statements are dominated by mandatory 
information about executive and board compensation. More information 
regarding charitable contributions and their supposed links to officers 
and directors will serve to further clutter the proxy statement
The main consequence of the new disclosure will be the unintended ones.
    The mandatory disclosure of charitable contributions could have 
negative, unintended consequence for both publicly traded companies and 
the charities and other non-profit organizations they support.
    The only contributions a company ought to make are those that 
benefit the business. While a relationship between an officer or 
director and the charity may exist, the reasons for any given 
contribution are usually many and varied. It is the legal duty of the 
managers and the board to insure that the corporate assets are not 
wasted. This requirement provides adequate safeguards.
    If all contributions must be disclosed, a new rule will likely be 
heard in many companies: ``you can't get in trouble for contributions 
you don't make.'' Mandatory disclosure of contributions will lead to 
the need to justify those contributions and the requirement to be able 
to defend those contributions. In those circumstances, a corporation 
may conclude that it is prudent to simply avoid making contributions 
where the recipient has any relationship to an officer or director. 
That course may be a disservice to the charity, and to the officers and 
directors. But it may be the prudent course.
                               conclusion
    For the reasons stated here, the Association opposes H.R. 887. We 
are very interested in the issues raised by the legislation. We would 
be pleased to provide more information should the Committee pursue this 
matter further.
            Very Truly Yours,
                                           Brian T. Borders
                                                          President
cc: Brent Delmonte
   Committee Counsel
   Committee on Commerce
   Washington, DC 20515-6115
                                 ______
                                 
                                    The Business Roundtable
                                                      July 23, 1999
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington D. D., 20509
Attn: Brian J. Lane, Director, Division of Corporate Finance

 Re: Proposed Disclosure of Charitable Contributions (HR 887)

    Ladies and Gentlemen: Thank you for the opportunity to address the 
proposed Bill introduced in the House of Representatives (HR 887), 
which would require disclosure of charitable contributions by issuers 
that have securities registered under Section 12 of the Securities 
Exchange Act of 1934, as amended. The Business Roundtable (BRT) 
includes the CEOs of many of the country's largest corporations, 
virtually all of which are significant contributors to the arts, civic 
projects, charities and other worthwhile organizations and activities. 
Virtually all of the BRT members and senior executives of many other 
major U.S. companies are actively involved in charitable activities 
and, consequently, any legislation or regulations impacting such 
activities are of concern to the BRT.
    The BRT believes the proposed requirement of disclosure of 
charitable contributions is unnecessary. For the reasons set forth in 
this letter, we believe the proposed disclosure is unnecessary for the 
protection of investors and is, at best, overbearing and unnecessarily 
burdensome. Many of the companies whose CEOs are members of the BRT 
already voluntarily make available reports of their charitable 
contributions to interested stockholders, and there has been no showing 
that there exists any abuse of corporate-giving programs to warrant the 
increased burden associated with the proposed legislative change. 
Moreover, if the Securities and Exchange Commission (``Commission'') 
were to determine that such disclosure was necessary, it has ample 
authority to require it without legislative or regulatory changes.
1. There is no justification for the proposed disclosure requirement.
    While some stockholders may have a special interest in knowing to 
which charities contributions have been made, no concern of general 
interest and materiality to stockholders is raised unless the 
contributions are so disproportionately large to the size of the 
reporting company as to amount to corporate waste or would otherwise 
reach the level where a director can be said to have failed to exercise 
his or her fiduciary duties. Under state corporate law, companies and 
their directors have a fiduciary duty to stockholders not to waste 
corporate assets. The decisions of a corporation on its community 
relations and charitable giving programs are quintessential business 
decisions, and under state law are within the purview to the board of 
directors and management. They involve considerations unique to each 
corporation, and its customer base and the communities in which it 
operates. Such decisions should not be made based on SEC disclosure 
policy or general stockholder referenda, but should be regulated 
pursuant to state law corporate governance standards. Further, state 
law provides sufficient ability for stockholders to regulate charitable 
``gifts'' by their companies through their right to review the books 
and records of the company and their ability to present and advocate 
stockholder resolutions addressing such activities. SEC-mandated 
disclosure, as proposed, regarding charitable contributions would be 
tantamount to substituting federal legislation for a matter that is 
properly one for state law.
2. Contributions to charitable organizations should be disclosed only 
        if there is a significant direct or indirect economic benefit 
        to an insider and the amount of the contribution is unusually 
        large.
    The proposed legislation would require disclosure in proxy 
statements and other consent solicitation documents of charitable 
contributions in excess of an amount to be determined by the SEC if a 
director, officer or controlling person of the donor company, or their 
spouse serves as a director or trustee of the charity. While, for the 
reasons stated above, we think a general disclosure requirement for 
charitable contributions is both bad policy and an unwarranted 
intrusion on areas regulated by state corporate governance laws, there 
may be a limited number of instances where disclosure may be 
appropriate. We believe that if proxy disclosure is required, it should 
only be required if an insider serves as a director or trustee of the 
charity and there would be a significant direct economic benefit to the 
insider. For example, a substantial donation to a ``private 
foundation'' controlled by the insiders would generally be disclosable 
under the above described standard. This disclosure would be 
appropriate because the insider would have discretionary power over the 
donated funds after the donation. Similarly, a grant to a research 
institution or university for the development of bio-tech products 
would be disclosable if the company had a technology development 
agreement with the university and a director of the company received 
research funds from such contribution. The standard proposed for proxy 
disclosure by the proposed legislation seems to imply that disclosure 
under all circumstances is warranted because the insider is perceived 
as having received a benefit as a result of, or in connection with, the 
company's charitable donation. When the insider is not receiving any 
significant direct economic benefit from the contribution, no 
disclosure should be required. Under all circumstances, the threshold 
amount of contribution to a charity before disclosure is required 
should be substantial. No disclosure should be required if the 
aggregate amount of a company contributions does not exceed 2.5% of 
consolidated revenues.
3. The proposed disclosure standards are unnecessarily complicated.
    As proposed, the bill distinguishes between proxy disclosure, and 
information regarding charitable donations that must be made available 
to stockholders annually, in a format to be prescribed by the SEC. 
Proxy disclosure is required only if the value of the charitable 
contribution exceeds an amount to be determined by the SEC, and then 
only if an insider serves as a director or trustee of the recipient 
charity. The bills proposed annual disclosure, however, would require 
an issuer to make available the aggregate amount of charitable 
donations made by it in any given year and, if any one particular 
charitable organization received donations in excess of an amount to be 
determined by the SEC, the name of such charitable organization and the 
value of the contribution made. As proposed, the annual disclosure is 
required even if no insider of the donor company serves as a director 
or trustee of the recipient charity.
    We do not believe that, absent a significant direct relationship 
between the charity and an insider of the reporting company, disclosure 
regarding charitable donations is necessary for the protection of 
investors, or consistent with the Commission's charter and with the 
authority of the states to regulate corporate governance. No evidence 
has been presented by the proponents of the bill to indicate that such 
disclosure will cure a significant level of abuse or provide material 
disclosure necessary for the protection of investors. The additional 
regulatory burden imposed on the issuer should be balanced against the 
benefit to be gained. Unless the amount of contributions are material 
to the financial statements or business of the Company we see no reason 
why the disclosure of charitable contribution needs to be bifurcated. 
We would suggest that any required disclosure be restricted to the 
proxy statement and to instances when there is an insider involved with 
the charity in the manner we have proposed in 2. above. Many, if not 
most, charitable organizations are subject to state and federal 
regulatory review (IRS) and substantial financial information is open 
for public scrutiny as a matter of law. The bifurcated disclosure 
standard is unnecessarily complicated and poses an unnecessary 
regulatory burden on an issuer. Rather than imposing different 
requirements, one standard for proxy statement and annual report 
disclosure should be devised and an issuer should be allowed to 
incorporate by reference in its annual report the disclosure in its 
proxy statement, as is currently permitted with respect to Items 11 
through 13 of Form 10-K.
4. If disclosure is deemed necessary, stockholder proposals with 
        respect to charitable donations should be precluded.
    If an issuer is required to make disclosure about charitable 
donations, such disclosure is likely to become the target of greater 
special interest group and political criticism regarding its choice of 
charities. Charities acceptable or even supported by one stockholder 
may be entirely unacceptable to another stockholder. The outcome of 
this could very well be a rash of stockholder proposals demanding that 
a particular charity be declared ineligible to receive future donations 
or that a different charity be the recipient of the company's gifts. 
The time and resources required to deal with such proposals alone would 
be a sufficient reason to limit the proposed disclosure. If, however, 
the proposed bill is enacted, it should at a minimum afford protection 
from stockholder proposals by declaring that charitable donations are 
``ordinary business'' under the standard of Rule 14a-8(i)(7) and thus 
not a proper subject for action by an issuer's stockholders unless the 
proponent clearly demonstrates that the relationship to the charity is 
significant to the business of the company.
5. The proposed disclosure could have a stifling effect on corporate 
        charitable donations and is not necessary for the protection of 
        investors.
    We believe that the bill's proposed disclosure requirement could 
have a stifling effect on corporate donations. To the extent that the 
gift programs of the companies become the target of stockholder 
complaints that either disagree with corporate giving generally or the 
specific recipients, it is likely that companies will restrict 
contributions to avoid the burden of disclosure. The negative impact on 
corporate philanthropy will almost certainly exceed any disclosure gain 
intended by the proposed statutory change. The central tenet of the 
securities laws is the protection of investors. What an investors needs 
to know to make an informed investment decision should not be equated 
with what a few investors, who may have a special interest or other 
non-corporate agenda, would like to know.
6. The legislation is unnecessary.
    Finally, legislation on this subject is unnecessary. The Commission 
has ample authority under the Securities Act of 1933 and the Securities 
Exchange Act of 1934 to require any disclosure relating to charitable 
contributions that is actually material to investors.
    We would welcome the opportunity for representatives of the BRT to 
meet with you on this matter.
            Very truly yours,
                                             William C. Steere, Jr.
                                 ______
                                 
Prepared Statement of Dorothy S. Ridings, President and CEO, Council on 
                              Foundations
    The Council on Foundations and its more than 200 corporate 
grantmaking members continue to be concerned about the possible 
negative effects of H.R. 887 on charitable giving. The bill would amend 
the Securities and Exchange Act to require disclosures of contributions 
to nonprofit organizations. Although H.R. 887 is an improvement over 
similar bills introduced in the last Congress, and although the Council 
strongly encourages grantmakers to issue periodic reports informing the 
public about their gifts and grants, we question the need for federal 
legislation in this area. Particular problems with the bill include the 
prospect that it may deter volunteering and diminish giving. In 
addition, the measure delegates substantial authority to the Securities 
and Exchange Commission without affording necessary guidance on how the 
SEC is to exercise that authority. Finally, the bill fails to address 
serious issues with regard to the scope of required disclosure.
    The Council on Foundations is a nonprofit association of more than 
1800 grantmaking foundations and corporations. (A list of our corporate 
members is enclosed.) We estimate, based on market projections and 
other factors, that the 235 corporate grantmaker members of the Council 
will make more than $2.5 billion in charitable gifts in 1999. In 
addition to their financial resources, corporations also provide 
volunteer time, expertise, and visibility to the organizations they 
support. They are a vital and integral part of the charitable private 
sector. We hope that you will take our concerns into account as you 
consider H.R. 887.
    Deterring volunteer activities. The first substantive provision of 
H.R. 887 would require publicly traded companies to disclose all 
contributions (above an amount to be set by the Securities and Exchange 
Commission) that the company makes to a nonprofit organization if a 
director, officer, or controlling person of the company is a director 
or trustee of the nonprofit. Disclosure also is required if a spouse of 
a covered individual serves on the nonprofit's board.
    Many companies encourage their employees to become involved in 
community organizations, and many employees respond by generously 
donating their time to serve on community boards. Many companies also 
like to direct their giving to charities with which their employees are 
involved. We are deeply concerned that the disclosure requirement will 
place a strongly negative cast on this practice, leading key corporate 
employees and their spouses to resign their charity board positions 
lest they be perceived as having done something wrong. There is much 
reason to believe that volunteering by key corporate employees 
strengthens the social fabric of their communities, but correspondingly 
little evidence that this practice harms shareholders.
    Discouraging Giving. The second provision of H.R. 887 requires 
publicly traded companies to disclose the names of nonprofits to which 
they made gifts and the amount they gave. Again, disclosure would be 
required only for gifts that exceeded a minimum amount to be 
established by the Securities and Exchange Commission. Currently 
corporations can decide whether and how they wish to publicize their 
gifts. H.R. 887 would remove this choice.
    We are concerned that this Congressional action could have an 
adverse impact on charitable giving by publicly traded companies. While 
the Council encourages companies to report their philanthropic efforts 
to the community, it would be naive not to acknowledge that charitable 
giving can be a sensitive issue for many corporations, especially those 
that deal directly with the public. We fear that some corporations may 
choose to eliminate giving programs rather than make disclosure. Others 
may decide to reduce the size of all contributions to a level below 
whatever minimum the SEC establishes. We urge you to keep in mind that 
corporate giving is an entirely voluntary expenditure. Nothing prevents 
a corporation from deciding that intrusive government regulation makes 
it undesirable to continue these gifts.
    Promoting red tape. Many publicly traded corporations have numerous 
operating divisions and subsidiaries, each of which may have its own 
budget for charitable giving. If this legislation is enacted some of 
these companies likely will be required to invest in new software and 
tracking capability to collect and centralize information about the 
identity of all recipients and the amount of each gift. This task would 
be complicated by the need to accumulate gifts over the course of the 
year to determine whether the total exceeded the threshold established 
by the SEC. A further difficulty is that the answer to the threshold 
question may depend on how the recipient is organized. For example, 
because chapters of the American Red Cross are not separately 
incorporated, it would be necessary to accumulate all gifts to the 
various chapters. By contrast, local YMCAs and YWCAs are separate 
corporations (although often with multiple operating units), meaning 
that gifts to each corporate entity would be separately tracked.
    Absence of necessary guidance to the SEC. H.R. 887 requires the 
Securities and Exchange Commission to establish a floor for both 
disclosure requirements. The only guidance to the SEC is that the 
amount it sets must be one that is ``consistent with the public 
interest and the protection of investors.'' The bill leaves the SEC to 
guess what this level should be, since even total giving through 
corporate giving programs rarely, if ever, rises to the level of 
materiality--the standard the SEC normally applies in determining the 
need for disclosure. The height of the floor will have a significant 
impact on the record keeping burden that H.R. 877 will impose.
    A related problem is that H.R. 887 does not include even the flawed 
provisions found in earlier versions of this legislation that attempted 
to reduce the size and scope of the burden the legislation would place 
on corporate givers. Thus earlier versions excluded from disclosure 
gifts of tangible property, gifts to public and private educational 
institutions, and gifts to local charities. The lack of similar 
provisions in this bill means that all gifts must be reported if they 
fall above the floor to be established by the SEC. Many corporate 
commenters on previous versions of this legislation also pointed out 
the burden involved if reportable gifts include all those made by a 
corporation pursuant to an employee gift matching program. H.R. 887 
does not give the SEC the discretion to adopt a rule excluding matching 
gifts, except to the extent that matching gifts falling below the 
established floor will not be required to be disclosed.
    The legislation also is vague on the gifts that must be disclosed. 
While the section heading is titled ``Disclosure of Charitable 
Contributions,'' the text of the legislation mandates disclosure in 
connection with ``contributions'' to ``any nonprofit organization.'' 
Charitable institutions--those organized and operated for a charitable 
purpose and exempt from tax under section 501(c)(3) of the Internal 
Revenue Code--are only one type of nonprofit organization. Examples of 
non-charitable nonprofits include trade and professional associations, 
civic leagues and social welfare organizations, social clubs, fraternal 
organizations, and a host of entities created for various pension and 
employee welfare purposes. H.R. 887 requires that contributions to 
these entities also would have to be tracked and disclosed.
    Normal corporate checks and balances protect investors and the 
public. Corporate management generally makes charitable contribution 
decisions. Corporate management is directly accountable to the 
directors who represent the shareholders. Shareholders who are unhappy 
about how their corporation is run have the option of voting to replace 
the directors. This system is not perfect. But it is far preferable to 
micromanagement by the federal government, particularly in the absence 
of any concrete evidence that corporate giving is harming investors or 
the public.
    In sum, the Council on Foundations is concerned that the risks of 
H.R. 887 substantially outweigh its benefits. We urge the subcommittee 
to consider carefully the need for injecting federal regulation into a 
system that currently works productively to provide substantial private 
voluntary support for a wide range of charitable organizations in all 
parts of the United States.
                                 ______
                                 
   Prepared Statement of the U.S. Securities and Exchange Commission
    Thank you for giving the Securities and Exchange Commission (SEC or 
Commission) the opportunity to present this statement concerning the 
disclosure of tax consequences of mutual fund investments and 
charitable contributions. The Commission fully supports the important 
goal of full disclosure, and welcomes this dialogue on these issues.
           i. the tax consequences of mutual fund investments
    One of the Commission's primary goals with respect to mutual fund 
disclosure is ensuring that funds clearly present their performance and 
costs to investors. H.R. 1089, the Mutual Fund Tax Awareness Act of 
1999, would address an important aspect of this issue, the effect of 
taxes on mutual fund performance. H.R. 1089 would require the 
Commission to revise its regulations to improve methods of disclosing 
to investors in mutual fund prospectuses and annual reports the after-
tax effects of portfolio turnover on mutual fund returns. In fact, as 
more fully described below, the Commission staff is already working on 
improving disclosure in this area.
Current Disclosure Requirements
    Mutual funds currently are required to disclose the following 
information about taxes in their prospectuses and annual reports:

 Tax Consequences. A fund must disclose in its prospectus the 
        tax consequences to shareholders of buying, holding, 
        exchanging, and selling the fund's shares, including the tax 
        consequences of fund distributions.
 Portfolio Turnover. A fund must disclose in its prospectus 
        whether the fund may engage in active and frequent portfolio 
        trading to achieve its principal investment strategies and, if 
        so, the tax consequences to investors of increased portfolio 
        turnover and how this may affect fund performance. A fund also 
        must disclose in its prospectus and annual reports the 
        portfolio turnover rate for each of the last 5 fiscal years.
 Distributions. A fund must disclose dividends from net 
        investment income and capital gains distributions per share for 
        each of the last 5 fiscal years in its prospectus and annual 
        reports.
Staff Consideration of Mutual Fund Tax Disclosure
    The Commission staff has been considering whether mutual fund 
disclosure requirements could be revised to provide investors with a 
better understanding of the tax consequences of holding and disposing 
of a fund, the relative tax efficiencies of different funds, and how 
much of a fund's reported pre-tax return will be paid out by an 
investor in taxes. There is no direct correlation between the portfolio 
turnover rate, which currently is disclosed, and shareholder tax 
consequences. For example, a fund with high portfolio turnover may 
produce relatively low taxable gain to investors if it offsets realized 
gains with realized losses.
    The Commission staff is considering whether there are other 
measures that could be used to convey mutual fund tax consequences that 
are understandable to investors and not unduly burdensome for funds to 
compute. Standardizing disclosure of the tax consequences of a mutual 
fund investment is complicated because different fund investors are in 
different tax situations and, therefore, may experience different tax 
consequences from the same fund investment.
    The Commission staff's considerations have focused on after-tax 
return, a measure of a mutual fund's performance, adjusted to 
illustrate how taxes could affect an investor. (The calculation of 
after-tax return requires a number of assumptions about the investor's 
tax situation, such as his or her tax bracket.) The staff is 
considering two separate measures of after-tax return:

 Pre-Liquidation After-Tax Return. This measure assumes that an 
        investor continues to hold the fund at the end of the period 
        for which the return is computed. It measures only the taxes 
        resulting to the investor from the portfolio manager's purchase 
        and sale of portfolio securities.
 Post-Liquidation After-Tax Return. This measure assumes that 
        an investor sells the fund at the end of the period for which 
        the return is computed and pays taxes on any appreciation (or 
        realizes losses). It measures both the taxes resulting from the 
        portfolio manager's purchase and sale of portfolio securities 
        and the taxes incurred by shareholders on a sale of fund 
        shares.
These measures of after-tax return could help investors compare the 
after-tax returns of different funds and gain an understanding of the 
impact of taxes on a fund's reported pre-tax return.
Anticipated Commission Action
    The Commission staff currently is preparing a recommendation to the 
Commission that it issue proposed rule amendments intended to improve 
the disclosure of the tax consequences of mutual fund investments. The 
proposed rule amendments, if issued, would be promulgated pursuant to 
the Commission's existing authority and would be the subject of public 
notice and comment.
  ii. disclosure of charitable contributions by public companies and 
                              mutual funds
    H.R. 887 is a bill that would require public companies and mutual 
funds to disclose information about certain of their contributions to 
non-profit organizations where an insider of the company, or a spouse, 
is a director or trustee of the organization. In addition, public 
companies would be required to make available disclosure of the total 
value of contributions made and identify the donees and amounts 
contributed if they exceed a dollar threshold established by the 
Commission.
SEC Staff Study
    At Representative Gillmor's request, the Commission staff has 
studied H.R. 887 and previous versions of the legislation. In fact, the 
staff requested comment from the public concerning the costs and 
benefits of the earlier legislation (H.R. 944 and 945). Nearly 200 
persons commented. The vast majority of the commenters opposed the 
previous legislation. The commenters supporting disclosure argued that 
improved disclosure would reduce abuse, improve accountability, reduce 
shareholder distrust, provide another basis on which to assess the 
judgment of management, and build goodwill with the companies' 
customers and community. Opponents of disclosure argued that it would 
be costly to track small contributions, especially for large companies. 
They believed that companies would reduce the amount of gifts to avoid 
disclosure or avoid giving to controversial charities. There was 
concern this disclosure could be used for political or personal 
agendas.
    After studying the issue, the Commission staff concluded that 
imposing the corporate charitable contributions disclosure requirements 
in H.R. 887 would be feasible in that public companies are capable of 
tracking and disclosing this information to investors. Many companies 
currently collect charitable contribution information for tax purposes, 
and a small number already voluntarily disclose this information to the 
public.
Current Disclosure Requirements
    Currently, shareholders have a right to make proposals in the 
company's proxy statement to provide disclosure of charitable 
contributions. Those proposals have not attracted substantial support 
from shareholders. The Business Roundtable has commented that few 
shareholders request information regarding charitable contributions 
from companies that provide this information voluntarily. This leads us 
to believe that a significant majority of shareholders may not consider 
this information to be important.
    In recent years, the Commission has been focusing much of its 
efforts on streamlining disclosure and mandating plain English. 
Charitable contributions account for a small portion of most companies' 
financial activities. We are cautious about adding disclosure that 
would add to the volume of detail given to investors without providing 
material information.
    In the course of reviewing H.R. 887, the Commission staff 
identified additional practical issues that may affect the 
implementation of disclosure requirements for corporate charitable 
giving. Although companies already track the amount of their charitable 
contributions and to whom they are made for tax purposes, they may not 
have in place mechanisms to identify gifts to organizations affiliated 
with corporate insiders and their spouses, in part because they are not 
currently required to do so. Also, depending upon the dollar thresholds 
for disclosure, the amount of disclosure and the corresponding cost 
burden will vary significantly. Finally, there are other technical 
issues that the staff would be pleased to discuss.
                            iii. conclusion
    The Commission supports the goals of H.R. 1089, the Mutual Fund Tax 
Awareness Act of 1999. Taxes have a significant effect on mutual fund 
performance, and the Commission and its staff are already working hard 
to improve the disclosure that funds make to investors in this area. 
The Commission remains concerned about H.R. 887. The Commission looks 
forward to working with the Subcommittee on these important issues.
                                 ______
                                 
                                                  OMB Watch
                                                   November 2, 1999
Representative Michael Oxley
Chair, Finance and Hazardous Materials Subcommittee
House Commerce Committee
2125 Rayburn House Office Building
Washington, DC 20515
    Representative Oxley: We are writing to ask that our statement be 
entered into the record of the recent hearing on H.R. 887.
    We strongly support the ideal of disclosure, and feel it is vital 
to a democratic society. A large part of our mission involves working 
for greater openness in government. While we realize that there can be 
some downsides to full disclosure, we feel that the benefits far 
outweigh any of these. Therefore, we view H.R. 887 as a positive start 
for greater disclosure of corporate philanthropy, although 
clarification is needed on several points.
    First, will the two disclosure requirements apply only to cash 
contributions made to nonprofits, or will they also include in-kind 
contributions? Many publicly held companies donate products that they 
manufacture, or services that they provide, to nonprofits. Also, many 
companies donate office equipment to nonprofits after making upgrades. 
It is important that these donations are also covered.
    Second, clarification of the disclosure process in Section 2 is 
required. Currently there is no indication of what the process will 
involve, as the legislation simply states that the disclosure statement 
must be made ``in a format designated by the [Securities and Exchange] 
Commission.'' We would strongly recommend that the data be widely 
available to the public using the internet. Also, allowing publicly 
held companies to submit the disclosure information electronically 
would ease any burden caused by the new requirements, as well as allow 
easy posting on the internet.
    Even though clarifications are still needed, we feel that this is 
an important piece of legislation because it obliquely serves to codify 
the practice of corporate philanthropy. As Representative Cox pointed 
out at the hearing, by regulating disclosure of donations by publicly 
held companies, this law indirectly states that corporate philanthropy 
is allowed under SEC regulations.
            Sincerely,
                                               Gary D. Bass
                                                 Executive Director
                  Increasing Corporate Accountability?
                     omb watch analysis of h.r. 887
                               (7/06/99)
Summary
    A bill introduced by Representative Paul Gillmor (R-OH) would 
require stock-issuing corporations that are registered with the 
Securities Exchange Commission (SEC) to disclose the amount of money 
they have given to charities each year, as well as the names of 
recipients of large grants, through two processes. The first would 
require the disclosure of any contribution over a limit to be set by 
the SEC to any nonprofit of which ``a director, officer, or controlling 
person'' of the corporation ``or a spouse thereof was a director or 
trustee'' to be included in the annual proxy statement. This would 
include the name on the nonprofit, and the amount of the contribution.
    The second process requires all corporations to annually ``make 
available'' the ``total value of contributions made by the issuer to 
nonprofit organizations during its previous fiscal year.'' This process 
would also require the name of the nonprofit organization receiving the 
donation to be included in the report, as well as the amount 
contributed, if the contribution is over an amount set by the SEC.
Background
    Gillmor proposed a similar piece of legislation in the 105th 
Congress (H.R. 944). That bill simply called for ``disclosure of the 
issuer's charitable contributions during the preceding fiscal year, 
including the identity of and the amount provided to each recipient.'' 
The legislation was not as comprehensive as this year's bill, H.R. 887, 
as it allowed the SEC to grant several types of exemptions. It was also 
partnered with another bill (H.R. 945) that would have required the 
approval of shareholders for any charitable contributions. Taken 
together, these bills would have created substantial barriers to 
corporate giving, and would have made contributions far less attractive 
to companies.
    Gillmor asked the SEC to evaluate the feasibility of requiring 
disclosure to shareholders in the spring of 1997, and the SEC finally 
released a report early this June. While the report covers general 
principles of disclosure, it focuses on H.R. 887. The report finds that 
the ``corporate charitable disclosure requirements in H.R. 887 would be 
feasible in that companies are capable of tracking and disclosing this 
information to investors.'' The report notes that many companies 
already track charitable contributions for tax purposes, and some 
already voluntarily disclose their contributions to the public. Gillmor 
also asked that the SEC perform a cost and benefit analysis, but this 
was not included in the report.
Analysis
    OMB Watch supports the ideals of accountability and disclosure in 
the nonprofit sector. This bill is a good beginning for greater 
disclosure. Unlike foundations, public corporations are not now 
required to disclose information about their contributions or grants. 
Principles have been in place for some time regarding disclosure of 
philanthropic endeavors. The Council on Foundations, for example 
encourages its members to disclose information about contributions in 
annual reports. It should not be difficult for a corporation to print a 
listing of contributions in its annual proxy statement. Further, the 
SEC should allow for electronic submission of the disclosure 
information for ease of submission, and post it on the internet for 
simple public access.
    Disclosure of charitable contributions by corporations should not 
be a controversial issue, nor is it costly to implement. If the intent 
of the bill is to increase corporate accountability, it is interesting 
that it only applies to corporate contributions. Why not include 
information disclosing lobbying expenditures, campaign contributions 
(both ``hard'' and ``soft'' money), expenditures for legislative, 
ballot and regulatory issue campaigns, as well as other information in 
annual reports? Disclosure of contributions to charities is a good 
start, but is only a small part of corporate accountability.
    Another important piece of the legislation is a provision that 
requires the disclosure of any contributions over a limit to be 
determined by the SEC made by a company to any nonprofit organization 
``of which a director, officer, or controlling person'' of the company, 
or the person's spouse is a ``director or trustee.'' This provision 
would allow the public to see contributions that may be made simply 
because of an executive's involvement with an organization. For 
example, under this bill a corporation which makes a contribution 
simply as a ``fee'' for an executive's seat on a nonprofit board may be 
required to disclose this contribution if it is above the SEC 
designated amount.
Potential Problems:
    As drafted, this legislation does not apply to corporate 
foundations. This could impede full disclosure, because a company 
seeking to avoid disclosure could simply make a large payment to its 
foundation, and then have the foundation make contributions. The 
company would only be obligated to disclose its contributions to its 
foundation (assuming that the contribution exceeds the threshold that 
is to be determined by the SEC). There will be some level of 
disclosure, however, because private foundations are required to 
disclose contributions in their IRS form 990-PF. While these documents 
are available for public inspection, they are most likely not delivered 
to shareholders on a yearly basis, as an annual report is.
    Another problem with this legislation is that contributions to 
charities where an executive is a director or trustee are only 
disclosed to shareholders, and not necessarily the general public. This 
disclosure is to be included with the written information distributed 
to shareholders before the corporation's annual meeting, which usually 
is an annual report. While most corporations will give a copy of their 
annual report to non-shareholders, they are under no obligation to do 
so. The general public should have access to a corporation's total 
charitable contributions as well as the names of charities receiving 
contributions over the threshold that is to be set by the SEC, 
preferably in an easily accessed electronic format. The legislation 
does state that this information must be made available ``in a format 
designated by the Commission,'' but does not state who this information 
is to be made available to, nor does it give any hint as to the format.
    It is unclear if this legislation applies to contributions made by 
U.S. companies to foreign nonprofit organizations. Donations made by 
U.S. corporations to foreign nonprofits may not be disclosed, as they 
are not tax-deductible, and may not fall under a final definition of 
``contribution.'' The legislation also appears to apply to 
contributions to U.S. charities made by foreign companies that are 
``registered'' with the SEC. These foreign companies may be subject to 
domestic laws that may conflict with the purposes of this bill, and 
there may be difficulty enforcing this legislation in foreign 
companies.
Conclusion
    While disclosure of corporate charitable contributions is the right 
thing to do, is unlikely to have a major impact on corporate 
accountability. Legislation is still needed requiring corporations to 
disclose other types of contributions, such as ``soft money'' campaign 
contributions. Further, because the reporting threshold has not yet 
been set by the SEC, the impact of H.R. 887 cannot be fully measured.
                                 ______
                                 
    Prepared Statement of Hon. John D. Dingell, a Representative in 
                  Congress from the State of Michigan
    The Subcommittee on Finance and Hazardous Materials held a hearing 
on H.R. 887, legislation to mandate the disclosure of certain corporate 
charitable contributions, and H.R. 1089, the Mutual Fund Tax Awareness 
Act of 1999, on Friday, October 29, 1999, when the House was not in 
session and only three Subcommittee Members (Reps. Gillmor, Markey, and 
Cox) were able to attend.
    The hearing was chaired by Rep. Gillmor, the lead sponsor of both 
bills. Rep. Gillmor announced that the hearing record would be held 
open to allow other Members to insert their statements. I appreciate 
that courtesy and will avail myself of the opportunity to clarify the 
record.
    First, I note that both bills amend the federal securities laws to 
mandate that the Securities and Exchange Commission (SEC) require 
certain disclosures. Yet, in a departure from usual subcommittee 
practice, the SEC was not invited to testify on the legislation. I have 
subsequently learned that the Majority did ask the SEC to submit a 
written statement but that statement was not made available to Members 
either before or during the hearing. It appears that the SEC statement 
raises concerns with at least one of the bills. I am submitting the SEC 
statement for inclusion in the record and circulating it to Democratic 
Members.
    Similarly, in May 1997, six Members of the Subcommittee wrote to 
the SEC asking for a report on predecessor legislation to H.R. 887. The 
SEC staff report was not distributed to Members with the briefing 
materials for this hearing or included in the hearing record. The 
briefing memorandum mentions the SEC staff report's finding that 
``imposing the corporate charitable contributions disclosure 
requirements in H.R. 887 would be feasible in that public companies are 
capable of tracking and disclosing this information to investors.'' 
However, it does not mention any of the concerns and problems that also 
were discussed. Therefore, I am submitting copies of the May 1997 
letter and the May 1999 SEC staff report for inclusion in the hearing 
record as well.
    No mention of a markup date was made at Friday's hearing. At 5:30 
p.m., after most offices were closed for the weekend, the Majority sent 
out a notice that both bills would be scheduled for Subcommittee markup 
on Tuesday, November 2, 1999. The SEC was not notified of the markup. 
No meeting has been scheduled in advance of the markup with the SEC to 
discuss and address their concerns.
    With respect to the substance, H.R. 1089 would require the SEC to 
revise its regulations to improve the methods of disclosing to 
investors in mutual fund prospectuses and annual reports the after-tax 
effects of portfolio turnover on mutual fund returns. SEC staff 
currently is preparing a recommendation to the Commission that the 
agency issue proposed rule amendments, under its existing statutory 
authority, with the intention of improving the disclosure of the tax 
consequences of mutual fund investments. This issue is complex, as was 
noted by the witnesses. Every investor's tax situation differs and, 
short of person-by-person disclosure, it will be difficult to craft 
meaningful disclosures. Any disclosure in this area will have to be 
accompanied by clear cautionary narrative informing investors of the 
appropriate use and inherent limitations of any new tax information. 
This legislation is not necessary, but may provide a beneficial prod, 
as long as the SEC is given sufficient flexibility in implementing the 
legislation's goals. The SEC has submitted a package of technical 
changes to H.R. 1089. These should be taken care of.
    H.R. 887 requires all SEC-registered companies to annually make 
available, in a format to be designated by the SEC, the total value of 
contributions made by the issuer to nonprofit organizations during the 
previous fiscal year. The name of the organization receiving the 
donation and the amount contributed also must be included in the report 
for any contributions over a threshold amount to be set by the SEC. 
H.R. 887 also requires SEC-registered companies to disclose in their 
proxy statements any contributions, over threshold to be set by the 
SEC, made by the issuer during the previous year to any nonprofit 
organization of which a director, officer, or controlling person of the 
issuer, or spouse thereof, was a director or trustee, including the 
name of the organization and the value of the contribution.
    Concern has been raised that this disclosure could be used in 
furtherance of improper political or personal agendas. Moreover, if the 
intent of the bill is to increase corporate accountability, it is 
curious that it only applies to corporate charitable contributions. 
Disclosure of contributions to charities is only a small part of 
corporate accountability. Why not include information disclosing 
lobbying expenditures, campaign contributions (both ``hard'' and 
``soft'' money), expenditures for legislative, ballot, and regulatory 
issue campaigns, as well as other significant information?
    In addition, the SEC staff report on H.R. 887 raises the following 
specific concerns:
(1) There does not appear to be evidence of widespread (or even 
        significant) abuse--only a handful of examples or allegations 
        have been provided.
(2) Information regarding charitable giving by corporations is 
        currently available:
     Some companies voluntarily make available information 
            regarding their charitable contributions to shareholders.
     Corporate private foundations are required, under IRS 
            regulations, to make a list of contributions available to 
            the public, and apparently the IRS is amending its 
            regulations to improve public access.
(3) There does not appear to be evidence of widespread shareholder 
        interest in obtaining this information:
     Companies that make such information available to 
            shareholders have found relatively low shareholder 
            interest.
     Only a small number of shareholder proposals for 
            disclosure of charitable contributions have been offered 
            and voted upon, and none have been approved by 
            shareholders.
(4) The information may not be material to investors since it may not 
        be considered relevant to a reasonable person's investment 
        decision, particularly if the donations are not improper:
     Corporations donate an average of a mere one percent of 
            their pretax income to charity.
     The SEC generally requires disclosure of information that 
            is is ``material'' so that disclosure is meaningful and 
            does not overwhelmshareholders. Only in very rare 
            instances, if at all, would corporate charitable 
            contributions meet any reasonable ``materiality'' standard.
(5) Companies may evade the disclosure required by the bill:
     By making contributions through their foundations;
     By making contributions below any threshold; and
     By characterizing payments as business expenses instead of 
            charitable contributions.
(6) The costs of compiling the information may not be as low as 
        proponents anticipate because companies may not have 
        centralized records of all types of contributions including 
        cash, products, services, use of facilities and time of 
        employees.
    I intend to vote against H.R. 887 in its current form.



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